Monetization of Developing Economies

Monetization, defined as the enlargement of the sphere of the monetary economy, is among the most significant aspects of the growth and development of the economies of less developed countries (referred to hereafter as LDCs). It involves the extension through time and space of the use of money in all its aspects—namely, as a medium of exchange, a unit of account, and a store of value—to the nonmonetized (subsistence and barter) sector. The monetization ratio, that is, the proportion of the total of goods and services of an economy that is monetized, in the sense of being paid for in money by the purchaser, is one of the most important characteristics of the level and course of economic development. It should, therefore, be “a major concern of quantity-minded economic historians … the statistical information now available is woefully inadequate, both for the present situation in the less developed countries and for the values of the ratio during earlier stages of development of the now advanced countries.” 1 However, while the importance of monetization is generally recognized, there has been hardly any systematic analysis of its conceptual and empirical aspects.2 Even studies that purport to deal with monetization suffer from the lack of an adequate conceptual frame of reference.3


Monetization, defined as the enlargement of the sphere of the monetary economy, is among the most significant aspects of the growth and development of the economies of less developed countries (referred to hereafter as LDCs). It involves the extension through time and space of the use of money in all its aspects—namely, as a medium of exchange, a unit of account, and a store of value—to the nonmonetized (subsistence and barter) sector. The monetization ratio, that is, the proportion of the total of goods and services of an economy that is monetized, in the sense of being paid for in money by the purchaser, is one of the most important characteristics of the level and course of economic development. It should, therefore, be “a major concern of quantity-minded economic historians … the statistical information now available is woefully inadequate, both for the present situation in the less developed countries and for the values of the ratio during earlier stages of development of the now advanced countries.” 1 However, while the importance of monetization is generally recognized, there has been hardly any systematic analysis of its conceptual and empirical aspects.2 Even studies that purport to deal with monetization suffer from the lack of an adequate conceptual frame of reference.3

Monetization, defined as the enlargement of the sphere of the monetary economy, is among the most significant aspects of the growth and development of the economies of less developed countries (referred to hereafter as LDCs). It involves the extension through time and space of the use of money in all its aspects—namely, as a medium of exchange, a unit of account, and a store of value—to the nonmonetized (subsistence and barter) sector. The monetization ratio, that is, the proportion of the total of goods and services of an economy that is monetized, in the sense of being paid for in money by the purchaser, is one of the most important characteristics of the level and course of economic development. It should, therefore, be “a major concern of quantity-minded economic historians … the statistical information now available is woefully inadequate, both for the present situation in the less developed countries and for the values of the ratio during earlier stages of development of the now advanced countries.” 1 However, while the importance of monetization is generally recognized, there has been hardly any systematic analysis of its conceptual and empirical aspects.2 Even studies that purport to deal with monetization suffer from the lack of an adequate conceptual frame of reference.3

A proper study of the monetization of LDCs is important for a variety of reasons. First, the nonmonetized sector in these economies, although not adequately measured, is known to be significantly large.4 Available evidence refutes the presumption that some LDCs are said to have virtually completed the absorption of the nonmonetized sector.5 In a number of LDCs, particularly in tropical Africa, Southeast Asia, and the South Pacific, the estimated share of the nonmonetized sector in gross domestic product (GDP) ranges from about one fifth to one third; for Nepal, it is more than 60 per cent.6 Given these magnitudes, the overall rate of economic growth of such economies could be said to be determined as much by the performance of the nonmonetized sector as by the monetized sector, as well as by their mutual interaction. Therefore, the economic rationale of the subsistence sector and its implications for development and welfare merit much closer attention than they have received so far.7 Second, although the rate, as distinct from the level, of monetization is an important variable for financial programming, studies of the demand functions for money in the LDCs do not allow for monetization per se.8 Even where such an allowance is made, it is based on casual empiricism because of lack of adequate data.9 The relevance of monetization in any adequate specification of the demand function for money has been well stated as follows: “What happens to the usual homogeneity postulate in the demand for money? Clearly, what is required is a well specified demand for money model using cross-sectional and dummy variables, and even here numerous specification problems need to be considered—in particular, one needs to account for the differences in monetisation between countries and over time.” 10 Finally, consumption in kind, treated as part of total consumer income, has important implications for determining tax incidence and overall fiscal policy in the LDCs.11

This paper is intended as a critical survey and analysis of the conceptual and empirical aspects of monetization, as well as a preface to further research to develop an adequate framework for cross-sectional and time-series studies of monetization, and thereby for more effective financial programming and policies in the LDCs. In Section I, the concept of monetization is analyzed and differentiated from the concepts of commercialization and financial intermediation. Section II discusses the nature and economic rationale of the nonmonetized sector, and Section III presents the problems of measuring monetization. Sections IV and V review the available empirical evidence, and Section VI analyzes the implications of monetization for monetary and fiscal policy. Section VII specifies a conceptual model of monetization and outlines an agenda for further research on monetization. Section VIII gives the principal conclusions of the paper.

I. The Concept of Monetization

The measurability of monetization depends upon an operationally significant concept of monetization. Conceptual confusions have led to reliance on misleading indicators of monetization in empirical investigations. Therefore, the concept of monetization merits careful analysis, particularly because of the tendency either to bypass the problem of defining and delimiting it or to use it indiscriminately as a portmanteau concept, embodying attributes of other phenomena, such as commercialization and financial intermediation.12 The term “monetization” itself is prone to a variety of usages. Thus, according to one writer, it “refers to the rate of use of money,” 13 which would make it identical to the quite distinct concept of velocity of circulation. Sometimes a distinction is made between monetization in the sense of using an object as currency and monetization meaning the evolution of monetary structures, with a further subdivision between internal monetization (i.e., in a closed economy) and external monetization (involving the evolution of the external monetary relations of an economy).14 According to Saint Marc, monetization is “a hinge concept,” in that it analyzes monetary structures—that is, the transition from barter to fiduciary currency, credit, and financial intermediation. His study is primarily concerned with establishing a statistical relationship between monetization, as he defines it, and development, and therefore does not deal with the more basic phenomenon of the rate of absorption of the nonmonetized sector into the monetized sector.

The distinction between monetization and commercialization becomes evident on closer analysis.15 Monetization connotes the enlargement of the sphere of use of money, but “there are no necessary implications about specific uses of the money or specific consequences of monetization.” 16 Commercialization indicates the pervasiveness of the behavioral assumption of profit maximization, regardless of the degree of monetization of either inputs or outputs. For any operation to be largely commercialized, the bulk of the output must be salable on the market. It is this dependence on the market rather than “interest” in markets, as argued by Neale,17 that is the distinguishing feature of commercialization. For instance, a system of family farming may sell the bulk of its output on the market and may therefore be described as commercialized, even if the bulk of its inputs are nonmonetized (e.g., use of non-wage labor). Consequently, monetization (measured by the proportion of the aggregate value of goods and services that is paid for in money by the purchaser) is a necessary but not a sufficient condition of commercialization, which is measured by the proportion of production sold to total production (i.e., the marketed surplus), or its obverse, the household consumption ratio (retention of output for home consumption).18 The distinction between monetization and commercialization is clearly observed in some studies relating to India, which note that the higher index of monetization (proportion of farm inputs purchased) of large farm holdings is qualitatively different from the monetization of very small holdings. For large holdings, the higher index reflects “a higher degree of commercialisation of production,” whereas for the small farms, “it is more a reflection of the distress conditions under which production is carried out and market involvement assumes a compulsive character.” 19 Similarly, the All-India Rural Credit Survey classified 75 districts, according to the type of their economy, into three major categories: (a) subsistence; (b) monetized (but not commercialized); and (c) commercialized and monetized.20

It is also important to differentiate between monetization and financial intermediation, which is defined as the process of mediation through institutions and instruments between primary savers and lenders and ultimate borrowers and is measured, for instance, by the financial interrelations ratio.21 It connotes financial deepening22 rather than widening (enlargement of the money exchange economy), which is the phenomenon expressed in the term “monetization.”

To conclude, monetization, commercialization, and financial intermediation, while distinct phenomena, can also be interdependent and concurrent in a developing economy. Since monetization is a necessary condition for both commercialization and financial intermediation, it is misleading to say that monetization can result from increased financial intermediation,23 although in some historical situations (such as an inelastic supply of basic currency) the banking system may have been instrumental in promoting monetization.24

II. Nature and Economic Rationale of the Nonmonetized Sector

The term “nonmonetized sector,” which comprises two distinct sets of economic activities that do not involve the use of money, namely, subsistence (i.e., goods produced and consumed at home) and barter, should really be understood as an aggregate of the imputed values of nonmonetary economic transactions in the national accounts, since there is no nonmonetized sector in the sense of a purely self-sufficient isolated sector, even in the least developed countries. As has been rightly observed, “there was no pure subsistence sector left in Africa but, instead, a continuous gradation in the share of subsistence activities in the production of households … defined as the production of goods and services which are subsequently found to have been directly used by their producers.” 25 The subsistence sector is thus “a set of nonmonetary economic activities undertaken by people most of whom also have some monetary activities.” 26 But there are varying combinations of subsistence and monetization, rather than a “continuum or spectrum from pure subsistence at one extreme to pure commercialization at the other.” 27

Of the two basic components of nonmonetized economic activities—subsistence and barter—the latter appears to be relatively unimportant from the point of view of the number of commodities traded and also in relation to total output.28 But even if barter transactions were significant, measuring them would be virtually impossible. For instance, in the national accounts of Papua New Guinea, which are notable for their exhaustive treatment of the nonmonetized sector, “it has not been possible to take into account in the estimation procedure any transactions (e.g. barter) between rural villagers or to estimate the value of any transactions in the nature of intermediate consumption which may occur in the production process.” 29 Barter transactions are therefore best grouped with subsistence activity in the national accounts.30

The distinguishing characteristic of nonmonetary economic activities is that the bulk of the output is retained by producers for their own use, which may be final (e.g., crops or livestock produced and consumed at home) or intermediate (e.g., use of seed from the previous harvest or building materials from the farm). But it does not necessarily imply that no monetized inputs are used in the production process or that no part of the output is sold for money. Nonmonetized savings and investment represent the formation of physical assets primarily for use oneself with or without nonmonetized inputs. These may include such activities as housebuilding, construction of fences, storage, land reclamation, contour embankments, digging and repair of wells. As with consumption, savings and investment can be regarded as a continuum, representing various degrees of monetization. An important component of non-monetized transactions is payments in kind, such as commodity loans, wages in kind, and sharecropping, of which the last is usually the major item. The nonmonetized sector in the LDCs typifies their dualism, since it combines some of the characteristics of both subsistence and commercialized economic activity. Its economic agents act both like households, on the risk aversion principle, and like firms, on the profit maximization principle. It is this combination of properties that poses most of the analytic and policy problems of dualism and monetization.

It is pertinent to inquire why, despite centuries of economic growth and development, and the fact that the “diseconomies of finance-in-kind induce monetization,” 31 nonmonetary economic activities survive so extensively in many LDCs. The explanation has been variously sought in terms of poverty, isolation, tradition, and inflationary pressures.32 While these factors are partly relevant, the more basic rationale is that under conditions of high risk and uncertainty in these economies, what the peasant seeks (according to Lipton, p. 331) are “survival algorithms, not maximising ones,” 33 which are a manifestation of optimizing behavior rather than of conservatism. The peasant’s noncommercial morality can also act as a safeguard against consumption of capital in agriculture, which may result from too strict an operation of the commercial ethos.34 The availability of food and other wage goods from the subsistence sector insulates economies to a considerable extent against inflation or other economic vicissitudes. On the other hand, accelerated monetization is also regarded as desirable in order to achieve a higher rate of economic growth.35 But to the extent that average, rather than marginal, productivity determines family earnings in agriculture in the LDCs, the operation of the price mechanism through its effects on marginal inputs is also considerably limited.

Thus, the LDCs may need to aim at an optimal rate of monetization that would maximize the welfare gains of the subsistence sector and its development potential in the form of nonmonetized investment, which, although undocumented for most LDCs, is considerable.36 It has been suggested that “as approximately 50 per cent of the labor time in rural areas in poor countries is not utilized, non-monetary capital formation is possible on a huge scale.” 37 This assumes that one may treat all the available labor time as part of the social overhead costs, in which case it is reasonable to regard any addition to physical output as socially desirable. There is, of course, a variety of possible techniques of mobilizing the savings potential of the nonmonetized sector, such as “linked public works,” 38 but these have also some distinct limitations.39

III. Problems of Measuring Monetization

indicators of monetization

In view of the multiplicity of suggested indicators, it is important to identify those that will measure the “widening” of the monetary economy, through the substitution of monetized for nonmonetized transactions, as distinct from its “deepening,” which would only indicate the increase of economic activity in the already monetized sector. The indicators of monetization may be broadly classified into (1) the macro-economic, based on aggregates, such as national accounts; and (2) the microeconomic, based on surveys of particular sectors or transactions, such as consumer or farm expenditures. While the macroeconomic indicators are the really significant indicators of monetization, sectoral indicators can also be useful for deriving suitable proxies, or as building blocks for the construction of macroeconomic measures of monetization.

We may, however, first examine whether some of the broadly socioeconomic indicators, such as urbanization, industrial employment, and production of cash crops, can function even as proxies. While it is at least arguable that the “process of monetization has been largely the result of the penetration of urban products into rural areas,” 40 it is misleading to suggest that “the pace of urbanization can directly indicate the rate at which monetization is taking place.” 41 Urbanization does not necessarily indicate that, in the aggregate, it has occurred through the absorption of predominantly subsistence rural areas rather than through an increase in the number or size of existing urban areas. Besides, even the urban sectors in such LDCs as India and Indonesia are known to have substantial nonmonetized flows. Similar objections would also apply to the use of the ratio of increased industrial employment to increased population,42 since the increase in industrial employment can occur independently of the rate of monetization. A more pertinent indicator of monetization would be the ratio of increase of hired labor to family labor, and the substitution of money wages for wages in kind. It has also been suggested that the diversion of acreage to commercial crops may serve as a partial indicator of monetization.43 But such shifts, which are often reversible, may also involve substitution among cash crops themselves, and therefore do not necessarily signify a final transition from subsistence to commercialized farming.44 Likewise, the monetized sector may expand through the exploitation of hitherto unused resources, rather than through conversion of the subsistence sector, as in Southeast Asia and tropical Africa.

aggregate and sectoral monetization ratios

Monetization can be expressed as a proportion of the monetized component to the total of relevant economic magnitudes—such as gross national product (GNP), area, population, occupational distribution—at a given time. But to derive a meaningful aggregative measure of monetization, it is essential to relate the monetized portion to the total volume of economic transactions. Consequently, the most representative measure of aggregative monetization would be the monetization ratio (defined at the beginning),45 which may also be termed the monetization factor.46 Since monetization is essentially a dynamic historical process, the monetization ratio at a given time needs to be supplemented by time series of national accounts at constant prices, since this alone can establish the rate of monetization (the annual percentage increase in the share of the monetized sector) as distinct from its level.

Sectoral monetization may be measured with reference to (a) inputs (ratio of purchased inputs (e.g., hired labor, seeds, fertilizer, implements, livestock) to total inputs),47 (b) outputs (i.e., the marketed surplus or its inverse, the household consumption ratio), and (c) consumer expenditures, through the use of sample surveys and studies of farming and household budgets (ratio of nonmonetized items in household consumption). However, since these magnitudes relate to variations along a continuum, it is not possible to establish a clear-cut dividing line between degrees of monetization in different sectors.

ratio of money supply to national income

Although it has been suggested that the ratio of money supply to national income can be regarded as a rough index of monetization,48 closer analysis shows that this ratio cannot be used even as an approximate index. First, a mere increase in the supply of money does not necessarily connote an enlargement of the money economy, since it may well reflect an increase in the supply of money originating from the existing monetized sector, rather than the absorption of the nonmonetized sector. This distinction is crucial, even if it is not always possible to disaggregate any given increase in money supply into these two separate components. Second, economies at comparable or different levels of development and initial monetization may have similar or dissimilar ratios of money supply to national income (Chart 1). There is, in fact, no systematic observed relationship between money supply and the levels and rates of monetization or of development and national income. Thus, there is a valid distinction between an increase in the quantity of money and an enlargement of the sphere of money transactions.49

Chart 1.

Selected Countries: Ratios of Money Supply to Gross National Product, 1965–74


IV. The Empirical Evidence of Monetization

monetization ratios and national accounts

Although there is an extensive literature 50 on the definition and measurement of the nonmonetized sector, published data on the non-monetized sector in the national accounts of LDCs are either totally lacking or extremely fragmentary. The few available are bench-mark estimates for a particular year (Tables 1 and 2). Although most countries make varying imputations for nonmonetary activities, most of them do not show the nonmonetized sector as a separate but integral part of the national accounts. The major exceptions are a few countries in tropical Africa (e.g., Kenya, Uganda, Tanzania) and the South Pacific (Papua New Guinea and Tonga). In fact, the two latter countries, especially Tonga, have by far the most detailed presentation of the non-market component of the national accounts of all developing countries (Tables 17-Table 21, in the Appendix).

Table 1.

Less Developed Countries: Mean Valuesof Nonmonetized Shareof Gross Domestic Product, 1969/701

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These mean values were calculated on the basis of the percentage shares in col. (a) of Table 2.

The total is for all countries in the three regions.

Table 2.

Less Developed Countries: Nonmonetary Outputin Relationto Gross Domestic Product (GDP) and Monetization Ratios

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Adapted from Derek W. Blades, Non-Monetary (Subsistence) Activities in the National Accounts of Developing Countries, Development Centre, Organization for Economic Cooperation and Development (Paris, 1975), p. 80. The nonmonetary shares refer to the “latest year available,” which in most cases is 1969 or 1970.

The monetization ratios have been calculated on the basis of the shares in col. (a).

Although the United Nations System of National Accounts (SNA) and the three major regional working groups on national accounts have consistently recommended more comprehensive coverage of nonmonetary economic activities,51 the follow-up of their recommendations has been grossly inadequate. The neglect of the nonmonetized sector in national accounts reflects both the statistical problems involved and (sometimes) the mistaken belief that it is unimportant because of absorption of the nonmonetized sector.52 Moreover, even where the non-monetized sector is relatively small, as in Latin America, its output may still form a substantial part of total output for large sectors, a factor of special significance in countries with pronounced economic disparities between classes and regions.53 The inadequacy of the national accounts for the nonmonetary sector is reflected in the fact that about the only reasonably usable cross-country data (and even these relate to one year—1969/70) are those in the special survey by the Development Centre of the Organization for Economic Cooperation and Development.54 The results of this survey, together with the available data for some of the South Pacific countries, suggest that the nonmonetized sector accounts for 20 per cent or more of total GDP in nearly 40 per cent of the reporting countries, and for 10 per cent or more in about two thirds of the countries (Tables 1, 2, 3 and Charts 2 and 3). The nonmonetized sector still seems to be substantial in tropical Africa, Southeast Asia, and the South Pacific, whereas Latin America appears to be the most highly monetized region in the Third World. But these estimates are likely to understate the real size and economic importance of the nonmonetized sector because of difficulties of coverage and measurement. The available evidence, although fragmentary and subject to considerable margins of error, is nevertheless adequate to establish the minimum orders of magnitude of the nonmonetized sector in the LDCs. It is thus possible to measure the levels and rates of monetization only if the national accounts are (a) disaggregated into monetized and nonmonetized sectors, as in Papua New Guinea and Tonga, and (b) presented in constant-price time series.

Table 3.

South Pacific Countries: Monetization Ratio, 1958 and 1966–741

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These ratios are derived from national accounts in constant purchasers’ values, except for Western Samoa, which is based on current prices and the value of subsistence output estimated by Ian J. Fairbairn, The National Income of Western Samoa (Oxford University Press, 1973).

Chart 2.

Selected Developing Countries: Nonmonetary Shares of Gross Domestic Product (GDP), by Regions, 1969/70

Source: Derived from Table A. 1 in Derek W. Blades, Non-Monetary (Subsistence) Activities in the National Accounts of Developing Countries, Development Centre, Organization for Economic Cooperation and Development (Paris, 1975), p. 80.
Chart 3.

Selected Developing Countries: Nonmonetary Shares of Gross Domestic Product (GDP), 1969/70

Source: Derived from Table A. 1 in Derek W. Blades, Non-Monetary (Subsistence) Activities in the National Accounts of Developing Countries, Development Centre, Organization for Economic Cooperation and Development (Paris, 1975), p. 80.

sectoral evidence of monetization

In the absence of disaggregated national accounts, the evidence for monetization has to be drawn from sectoral data on typical inputs and/or factor payments (measured by the proportions of commodity loans, family labor, sharecropping, taxes in kind, etc.), and output (measured by the marketed surplus of major subsistence crops). The sectoral analysis of monetization is useful not only as a building block for aggregate monetization ratio but also to illuminate the spatial or temporal aspects of monetization, because “even with the full spread of the exchange economy in the markets for products, there may be considerable variations in the spread of the money economy to the markets for factors of production.” 55 But the sectoral data on monetization of inputs in most of the LDCs are much too fragmentary to permit any but purely illustrative observations.56 Consequently, the succeeding sections are based exclusively on the available data from India (consumer expenditure and rural credit surveys) and Indonesia (urban household income surveys).57

India: nonmonetized transactions

The available Indian data on nonmonetized flows, which are among the most comprehensive of their kind, are based on surveys and estimates of consumption, capital formation, inputs of household industries, farm accounts, etc. Given the diversity of sources and methods, it is not surprising that the evidence on the overall trend of monetization in India is ambiguous and even conflicting (Table 4). Thus, an early study based on a sample of households in 1955 concluded that the degree of monetization is independent of the level of income,58 whereas a subsequent study, based on comparisons of ratios of cash sales to gross value of produce in 21 districts derived from the All-India Rural Credit Surveys, found no evidence of the growth of monetization during 1951–59.59 A more recent (1948–68) estimate places the annual compound rate of increase in the degree of monetization of private consumption and investment at 0.7 per cent and 0.2 per cent, respectively.60

Table 4.

India: Degreeof Monetizationof Consumption, Investment, and Income

(In per cent)

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Source: B.B. Bhattacharya, Short-Term Income Determination (New Delhi, 1975), p. 34.

Bhattacharya, op. cit.

Central Statistical Organization, Government of India. These estimates, which are based on a detailed flow of funds analysis, are not available beyond 1957–58.

The findings of the three rounds of the National Sample Survey (NSS) over the period 1951–52 to 1957–58 61 (Tables 5-6) suggest that about 36–37 per cent of household consumption expenditure was nonmonetized, and of this a large part represented consumption of home-produced goods; the rural percentage was between 43 and 44 and the urban, between 8 and 11. Nonmonetized rural capital formation was about 25 per cent of the total in the period 1957–60.62 About one third of the rural industrial input was nonmonetized, whereas the input of urban household industries, except cattlefeed, was almost wholly monetized.63 The data suggest some small reduction in the nonmonetization of consumption at the national level, but it appears to have increased for major items, such as cereals and milk and milk products, with the increase in average household expenditure. Broadly, non-monetization was highest for consumption, intermediate for inputs of household industries (and probably also for total inputs), and lowest for investment; it was highest in villages, intermediate in urban areas, and lowest in the largest cities. In respect of aggregate consumption, it declined slowly in rural areas but more rapidly in urban areas, with a higher standard of living. Despite their limitations, these findings demonstrate the usefulness of sample surveys in illuminating different facets of monetization. Most of these findings could well be applicable to other LDCs, but an interesting counterintuitive finding is the tendency of nonmonetization of some Indian consumption flows to increase with an improved living standard.

Table 5.

India: Nonmonetized Consumptionas Percentageof Total Household Consumption

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Source: The National Sample Survey, No. 71, “Consumer Expenditure by Levels of Household Expenditure” (Government of India, 1962).
Table 6.

India: Percentage Shareof Nonmonetized Consumption Expenditure

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Source: The National Sample Survey, No. 18, “Tables with Notes on Consumer Expenditure” (Government of India, 1959) and No. 71, “Consumer Expenditure by Levels of Household Expenditure” (1962). Reference periods for the three rounds are as follows: 3rd round, August-November 1951; 4th round, April-September 1952; and 13th round, September 1957-May 1958.

Indonesia: nonmonetized components of urban incomes

A two-stage stratified random sample survey of the urban cost of living (1968–69 and 1970–71) also indicated a remarkably high nonmonetary component (about 17 per cent) of total family income in the seven principal cities.64 The major nonmonetized item was part-payment in kind of wages and salaries, which accounted for 75 per cent of all nonmonetary income in Jakarta and 58 per cent in other cities. The principal component of wages in kind was rice, amounting to 29 per cent of the total family expenditure on rice, followed by imputed rent of owner-occupied houses (19 per cent) and consumption of home-produced goods (9 per cent). The part-payment of wages in kind, which prevailed even in the 1950s, became more important as part of official policy to insulate family incomes from the effects of inflation. To this extent, the nonmonetized part of urban incomes could be said to be a policy-induced component rather than a structural element, as in rural areas.

The broad findings about the seven cities surveyed in 1968–69 (Table 7) are as follows:

Table 7.

Indonesia: Nonmonetary Incomesin Seven Cities, 1968–69

(In per cent)

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Source: Cited by R. M. Sundrum, “Household Income Patterns,” Bulletin of Indonesian Economic Studies, Vol. 10 (March 1974), p. 88.

(1) The proportion of nonmonetized income declined fairly steadily as income rose, which at lower levels was due to a decline in the consumption of home-produced goods and at higher levels, to a decline in wages and salaries received in kind. (2) It increased rapidly with the size of the family (except for the largest ones), mainly because the increase in the proportion of wages and salaries received in kind was probably at least partly related to the size of the family. (3) It declined with the number of wage earners in a family (except for the small group of families with six or more earners). (This is so because heads of families received food rations in kind for themselves and their dependents, while the additional earners in the family earned mainly cash incomes.) (4) It varied greatly according to the occupational distribution of heads of families. Nonmonetized income was a relatively large part of the total in agriculture because of the large volume of goods produced and consumed at home; in government service, mining, and quarrying, a high proportion of the wage income was paid in kind.

Asia: nonmonetized factor payments (wages, rent, and interest)

The significance of the relative shares of family labor to total farm labor and of wages in kind in the wage bill of farm households lies in the fact that if farmers pay money wages to hired labor, they have to sell their output on the market in order to make the wage payments. Likewise, it is useful to know the extent to which family labor is sold for cash employment outside the household.

In India, a considerable part of the wages of agricultural laborers is paid in kind, either in grain or (sometimes) in the form of cooked meals or in other perquisites.65 The data for India (Table 8) seem to suggest that the percentage remunerated in money showed a decline in 1956–57, compared with 1950–51 in all States except the Punjab. But in view of differences between the scope and methods of the successive rounds in this Enquiry, no clear-cut inferences can be drawn regarding their effect on the monetization of the agricultural labor market. Even so, the data are useful in establishing the prevalence of a substantial nonmonetized rural wage sector.

Table 8.

India: PercentageofMan-Days Workedby Casual Adult Workers Under DifferentModesof Wage Payment, 1950–51 and 1956–57

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Source: Labour Bureau, Agricultural Labour in India: Report on the Second Agricultural Labour Enquiry, 1956–57, Vol. I: All-India (1960), p. 107.

But rentals in kind and sharecropping appear to be more widespread than part-payment of wages in kind in the LDCs in Asia. The substitution of cash rentals for fixed rentals in kind and sharecropping is a good indicator of the monetization of a rural economy. Thus, although the data on the relative magnitudes of rents in cash and in kind in Malaysia as between 1957 and 1965–68 (Tables 9 and 10) are not uniform in coverage, they underscore the growing popularity of cash rentals and point to a strong positive association between cash rentals and commercialized high-productivity farming. Conversely, states with a low-productivity farming area are characterized by a high proportion of rents in kind. In India, the results of the farm management studies covering selected cultivator households in four States in 1955–56 showed that it did not extend to more than one fifth or one fourth of the cultivated area (Table 11). But it is difficult to draw any inferences regarding the monetization of rents because of the absence of comparable data over time.

Table 9.

Malaysia: Paddy Area, Classifiedby Tenure, 1957

(In per cent)

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Source: T.B. Wilson, The Economics of Padi Production in North Malaya: Part I—Land Tenure, Rents, Land Use and Fragmentation, Department of Agriculture, Bulletin No. 103 (Kuala Lumpur, 1958), p. 11.
Table 10.

Malaysia: Typeof Rentals, 1957 and 1965–68

(In per cent)

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Source: Figures for 1957 calculated from data in T.B. Wilson, The Economics of Padi Production in North Malaya: Part I—Land Tenure, Rents, Land Use and Fragmentation, Department of Agriculture, Bulletin No. 103 (Kuala Lumpur, 1958), and those for the period 1965–68 calculated from data cited by Yukon Huang, “Risk, Entrepreneurship, and Tenancy,” Journal of Political Economy, Vol. 81 (September/ October 1973), pp. 1241–44.

Selangor is double-cropping area of high productivity.

Table 11.

India: Cultivated Area Under Rentsin Kindand Sharecropping, 1955–56

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Source: Government of India, Studies in Economics of Farm Management in Bombay, Uttar Pradesh, West Bengal and Punjab.

Monetization and interest rates

The share of credit transactions in kind is an important indicator of the extent of monetization (Table 12). In such transactions, which are characteristic of the informal credit sectors in the LDCs, the principal, interest, and amortization are typically in commodities, such as foodgrains or oilseeds.66 Quite often, loans are made by moneylenders-cum-merchants in cash, but the repayments are in kind at a stipulated price, which is usually well below the market price of the commodity. But it is difficult to judge the magnitude of these transactions from the very fragmentary available data. The sample survey for the Philippines found that 37 per cent of total borrowings of farm households were in kind (mostly from landlords), of which about 68 per cent were in food supplies, such as rice, corn, tobacco, drinks; about 15 per cent in fertilizer and other farm supplies; and about 10 per cent in house furnishings and building materials.67

Table 12.

India: Nonmonetized Loansand Rural Interest Rates, 1951–52 and 1956–57

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Source: Reserve Bank of India, All-India Rural Credit Survey, Vol. I: The Survey Report, Part I—Rural Families (Bombay, 1956), p. 343. These are selected districts with high proportions of grain loans from among 23 districts in which more than 10 per cent of the selected families reported borrowings of grains.

Source: Reserve Bank of India, Rural Credit Follow-Up Survey, 1956–7, General Review Report (Bombay, 1960), p. 124. These data relate to all strata of cultivators.

Source: Reserve Bank of India, All-India Rural Credit Survey, Vol. II: The General Report (Bombay, 1954), pp. 190–93.

The level is determined by the proportion of borrowings (excluding borrowing at unspecified rates of interest) at rates of 18 per cent or more to the total borrowing from the principal private credit agencies: 93.7 per cent is a very high level; high is 77 per cent; medium is 54.3 per cent; low is 23.4 per cent; and very low is 3.9 per cent.

The data for India show that although commodity loans are not as important as monetary borrowings, they are significant in regions of noncommercialized small-scale subsistence farming.68 Foodgrain loans are made mainly to meet current farm expenditure (chiefly for seed and payment of wages in kind to farm laborers) and the remainder are for family consumption. The commodity loans are mostly repaid within the agricultural year, unlike cash loans, where a comparatively smaller proportion appears to be repaid within a year. Consequently, comparisons between total borrowings during the year in commodities and in cash provide a better basis for judging the relative importance of credit transactions in kind at a given time. But since the two All-India Rural Credit Surveys (AIRCS) were designed for purposes other than measuring monetization, no conclusions can be drawn regarding the relative share of grain loans over time. But the other findings of the Surveys showed (a) that village moneylenders in 37 of the 75 selected districts said that they had advanced grain loans and (b) that grain loans appeared to be most concentrated in districts in the (eastern) region of low monetization.69 It may be that, in India, monetization “accelerated rural indebtedness,” 70 but, equally, one can argue that monetary indebtedness, in turn, accelerated monetization.

It has been argued that “while empirically a negative association exists in intercountry comparison between monetization ratio and interest rate level, one could not claim that μ [i.e., the monetization ratio] depends on the level of interest rates. The causal relationship, if any, rather runs in the opposite direction, the process of monetization tending to decrease the level of interest rates as a capital market develops.” 71 But the relationship between monetization and interest rates is difficult to test because of the lack of any clearly defined channels of transmission between them. It is obvious that countries with high monetization ratios are also those with highly developed capital markets and, consequently, low interest rates. However, the relationship; if any, would seem to lie more directly between high savings ratios and broad and active capital markets, on the one hand, and the level of interest rates, on the other hand. The monetization ratio per se has little direct bearing on interest rates. The more significant causal relationship would seem to be between the degree of financial intermediation and the level of interest rates. It is the process of financial intermediation, rather than monetization, that will lower interest rates by broadening the capital market. In view of this, the econometric tests of the relationship between monetization and the rate of interest in India (using the AIRCS data) would not seem very meaningful.72 The three studies of Indian data suggest (a) an inverse negative correlation between the rate of interest and the degree of monetization and the share of institutional credit73 and (b) that in highly monetized districts interest rates were significantly low, while in high subsistence districts they tended to be high. One possible explanation for these results is the much higher degree of price-risk premium on commodity loans, which are more prevalent in the subsistence areas. But, as the authors themselves realize, these findings have to be accepted with extreme caution because of the limitations of the data.74 The nature of the AIRCS classification also greatly reduces the sample size; and there is no information on the degree of monetization of each district. An econometric analysis of two successive AIRCSs concluded that the rate of interest declines by 0.8 per cent to 1.3 per cent for a 10 per cent rise in the share of institutional credit, and by 1.9 per cent to 2 per cent with a 10 per cent increase in the degree of monetization, other variables remaining the same.75

The different components of interest rates in the LDCs—namely, the unit opportunity-cost of lending money, the unit costs of administering loans, the unit risk-premium, and the unit monopoly profits of money-lending—are not directly affected by the monetization factor. The prevalence of loans in kind no doubt raises the effective cost of credit to the borrower. But this is not because of the repayments in kind, per se. Rather, it is the combination of moneylending and trading that enables the lender to appropriate both monopolistic and monopsonistic profits.76

monetization of output (marketed surplus)

The time series of the marketed surplus of principal subsistence crops, livestock, etc., is a useful proxy for monetization 77 (Table 13). Besides, the variations in the marketed surplus have major implications for monetary policy.78 Markets for products tend to be monetized earlier, as well as more rapidly and extensively, than those for factors of production, because as growth and development proceed, the fraction of the total product sold on the market tends to increase faster, in the early stages, than the fraction of inputs bought.79 This is so because markets for commodities are less governed by social and conventional influences than are the markets for labor. Consequently, the ratio of marketed surplus keeps rising over time, under the cumulative impact of monetization, commercialization, and economic development, and, conversely, the ratio of the consumption of home-produced goods to total production declines, not necessarily to zero but to some critical minimum limit, which varies between households, sectors, and regions.

Table 13.

India: Time-Series Analysisofthe Marketed Surplusof Agricultural Productstothe Nonagricultural Sectorfor Intermediateand Final Consumption, 1951–66

(In crores1 of rupees)

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Source: R. Thamarajakshi, “Intersectoral Terms of Trade and Marketed Surplus of Agricultural Produce, 1951–2 to 1965–6,” in Readings in Indian Agricultural Development, ed. by Pramit Chaudhuri (London, 1975).

One crore is equal to ten million rupees.

V. The Historical and Dynamic Aspects of Monetization—An Asymptotic Process

Since monetization by its very nature is a secular process, its historical aspects are clearly germane to any comprehensive study of the subject. But while there have been several useful qualitative studies,80 there have been no systematic quantitative studies to date on its historical aspects because of the paucity of relevant data.81 Nevertheless, the available evidence permits a few broad observations.

First, monetization is essentially an evolutionary process and has not been a conscious object of policy in most LDCs, except in tropical Africa and the South Pacific. In these regions the prime instruments of monetization have been the introduction of cash and export crops, such as cocoa in West Africa; the transformation of existing subsistence crops into export crops (bananas in Western Samoa);82 the imposition of new money taxes, such as poll and hut taxes, to force workers into the money economy; the introduction of “general purpose money”;83 and the sale of “incentive goods,” such as textiles, processed foods and beverages, and consumer durables. Recent Asian experience, however, also demonstrates the use of deliberate restraint on monetization to mitigate the burden of inflation (part-payment of wages in kind in Indonesia) or to ensure an adequate marketed surplus of rice (in the Republic of China through the rice/fertilizer barter exchange program and the levy in kind of land taxes and land price payments).

Second, as monetization is a discontinuous process, it naturally varies between regions and countries and over time.84

Third, increasing monetization is an inevitable concomitant of secular growth and modernization, which accounts for the close association of high monetization ratios with high levels of development and per capita income among countries. This relationship cannot, because of the present availability of data, be tested by time-series analysis. Therefore, the alternative method of a cross-sectional analysis between the share of the nonmonetized sector and per capita GDP was attempted by Blades for 22 sub-Saharan countries, which were considered to be a sufficiently numerous and reasonably homogeneous regional group.85 His regression results (standard deviations in brackets) could be interpreted to mean that for these countries an increase of 1 per cent in per capita GDP is, on average, accompanied by a fall of about 0.6 percentage point in the percentage share of nonmonetary value added.

log y = 6.355 − 0.632 logx,n=22,R¯2=0.674(0.233)(0.477)(0.095)
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The R2 suggests that only about two thirds of the variation in nonmonetary shares is accounted for by the level of per capita GDP. But the limitations of the basic data, recognized by Blades, should be carefully noted. First, the reported nonmonetary sectors are a heterogeneous group, which may be related in different ways to changes in per capita GDP. Second, the data range from a basis of rural and household surveys to guesses. Third, while the nonmonetary shares refer to GDP at factor cost, the per capita GDP figures are World Bank estimates based on GNP at market prices. Fourth, structural differences in land tenure, cultivation, and income distribution affect the results. But, in addition, there is the inherent weakness of testing the relationship between two such omnibus variables as the monetization ratio and per capita GDP. Moreover, the results are vitiated by “double counting” insofar as the per capita GDP variable includes nonmonetary imputations.

The even more acute data constraints for the Asian countries preclude even a cross-sectional analysis. However, the author attempted a regression (adjusted for serial correlation) for Papua New Guinea (1961–74) to analyze the relationship between the share of the nonmonetary sector (PNM) and per capita income (PCY), which gave the following results:


In this type of logarithmic function, the rate of change between two variables is constant and equal to the coefficient of the independent variable (i.e., in this case the rate of change (i.e., elasticity) is –0.448). Both the constant and the coefficient are significant by the t-test at the 99 per cent level of confidence (figures in parentheses are t-statistics). These results mean that for Papua New Guinea an increase of 1 per cent in per capita GNP is, on average, accompanied by a decrease of 0.448 per cent in the percentage share of nonmonetary value added. But these results must be accepted with due reservations, because, among other things, the coefficient of determination (R2) shows that only a little more than one half of the variation in the nonmonetary GNP is accounted for by the level of per capita GNP. The one-equation model for Papua New Guinea that predicts nonmonetary GNP underestimates the actual nonmonetary GNP for the years 1962–63, 1968–71, and 1972–73 and overestimates the actual nonmonetary GNP for 1964–67 and 1974 (Chart 4). The periods where the model predicted nonmonetary GNP relatively closely are 1968, 1971, and 1973. Nevertheless, the model does seem to capture accurately the long-run trend of the nonmonetary sector to decline (Chart 5).

Chart 4.

Papua New Guinea: Predicted and Actual Gross National Product in the Nonmonetary Sector, 1961–74

Chart 5.

Papua New Guinea: Ratio of Market and Nonmarket Component to Gross Domestic Product at Constant Prices, 1966–74

Source: Based on Bureau of Statistics, National Accounts Statistics, 1960–74 (Port Moresby).

Given the strong positive correlation between monetization and economic growth, it is reasonable to assume that the relative share of the nonmonetized sector would decline, but the impact of economic growth on its absolute share may be indeterminate or at any rate nonproven, pending more definitive statistical tests. Therefore, Blade’s conclusion that “for most developing countries non-monetary output is increasing in absolute terms and will continue to do so” 86 must be treated as still tentative. However, monetization could be said to stop short of the complete absorption of the nonmonetized sector because even the most developed economies would always have some irreducible minimum component of nonmonetary imputations (Table 14). There are, of course, major differences between the nature and rationale of the traditional production-oriented nonmonetary subsistence sector in LDCs and the consumption-oriented households in developed economies. The developed economies tend to have an expanding nonmarket sector because of the accumulation of consumer durables, which, by satisfying wants formerly supplied through the market, contract the market economy. While these consumer assets reduce the service component of the monetary sector, they do not altogether eliminate or reduce the monetary inputs into households as do public utilities.87

Table 14.

Three Developed Countries: Monetization Ratios1

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Source: Adapted from Raymond W. Goldsmith, Financial Structure and Development (Yale University Press, 1969), pp. 304–308.

The three monetization ratios are defined as follows, depending on the coverage of nonmonetary imputations:

Mr1 = (a) agricultural production consumed by farmers; (b) imputed rent on owner-occupied houses; (c) financial services

Mr2 = Mr1 + use of (d) government structures; (e) consumer durable goods

Mr3 = Mr2 + (f) value of housewives’ unpaid services

The National Income and Product Accounts of the United States, 1929–65, Department of Commerce (Washington, 1966), pp. 152–53.

The ratios for Yugoslavia are derived from D. Dimitrijevic, “The Financial Structure in a Changing Economy” (mimeographed, National Bank of Yugoslavia, December 1965), p. 5. According to Goldsmith, this probably does not include nonmonetized income on government structures and equipment and consumer durables and, hence, must be compared with the narrower definition of nonmonetized income. The share of personal consumption of own production and receipts in kind in Yugoslavia in the national accounts fell from about one fifth in 1960 to a little over one tenth in 1971, United Nations, Yearbook of National Accounts Statistics, Vol. II (1972), p. 716.

The historical trend of monetization is likely to be of the shape shown in Chart 6, which plots a rather stylized time path of the monetization ratio from the origin denoted by an open interval 0, since there is no historical example of a completely nonmonetized economy. The kinks in the range 0m of the chart reflect the historically irregular character of the monetization process. The family of curves A1, A2, A3, A4 (in Chart 6) is intended to show that after a certain threshold (M), the time path Mrt becomes asymptotic to 0m (the limit defined by a fully monetized economy). The path A, which is nearest to 0m, is likely to be typical of developed countries, whereas the curves A1, A2, A3, A4, approximate to the typical range of monetization ratios (say, about 0.80, or a nonmonetized sector of about 20 per cent) in the less developed countries. Since a completely monetized economy, like the pure subsistence economy, is a notional limiting case, one must qualify the statement that monetization is a process that is “irreversible [except in the case of hyperinflation when flight from cash into goods takes place] and continuous until the whole economy is monetized.” 88

Chart 6.

Time Path of Monetization


It is pertinent to inquire whether monetization is affected by the institutional differences between market-oriented and centrally planned economies. The unusually rapid rise of the monetization ratio in Yugoslavia between 1953 and 1963 has been attributed partly to institutional changes and partly to industrialization, but there is said to be “no significant difference in [the monetization ratio of Yugoslavia] compared to free enterprise economies of similar level of development.” 89 This would imply that factors other than central planning are more significant determinants of the monetization ratio. In the Soviet Union, deliberate monetization of the kolkhoz (collective farm) sector through replacement of payments in kind to labor and obligatory deliveries of farm produce has been an important policy instrument,90 but collectivization per se does not seem to have affected the pace of monetization.

It is interesting to speculate why the monetization ratio has not qualified as one of the Great Ratios of economics—such as the savings-income ratio, the capital-output ratio, the capital-labor ratio—for the income velocity of circulation.91 The deficiencies of data only partly explain this omission. A plausible explanation is that “enough is known about this ratio, however, to feel confident that for the … last one hundred years for now developed countries and the last fifty years for the rest of the world, the change in the monetization ratio is not great enough to explain a substantial proportion of either present differences between developed and less developed countries in the level of FIR or of the ratio of financial issues or assets to national product, or to account for much of the trend of the ratio in either developed or less developed countries.” 92 Nevertheless, there is a pressing need to fill gaps in the data on the past behavior of the monetization ratio; since monetization is a long-term secular process, “the most useful approach to the problem at its most fundamental level may well consist of an economic-history-cum-sociology model of the development of the use of money, on the lines of Sir John Hicks’s A Theory of Economic History, rather than of a maximization-subject-to-constraint model of a monetary economy on the lines of the same author’s Value and Capital” 93

VI. Implications of Monetization for Monetary Policy and Fiscal Policy

monetary policy and programming

Broadly, the following variables are relevant for determining the optimal rate of monetary expansion consistent with relative price stability: (a) the rate of increase in the monetized GNP; (b) the growth of population (although monetary policy alone could not prevent the increase of population from causing either a progressive rise in prices or a progressive fall in per capita incomes); (c) the rate of monetization; and (d) the demand for larger cash balances, with rising per capita incomes resulting from (a) and (b).94

Monetization can affect money supply and velocity through (a) the transactions motive and (b) the precautionary and speculative motives (the asset motive) leading to an increase in the corresponding type of cash balances. It would be more realistic to disaggregate the Keynesian M (transactions and precautionary motives) so that the transactions motive is differentiated from the precautionary motive, which is more akin to the Keynesian M2 (the speculative motive). This would mean that M1 = transactions and M2 = precautionary and speculative motives; the latter would then represent the asset motive rather than the transactions motive. The replacement of payments in kind of wages, rent, interest, and taxes, or other customary payments, would clearly lead to an increase in transactions balances. The commutation of feudal dues in medieval Europe, and the cash exemption from compulsory labor services (the corvee) and its eventual replacement with a capitation tax in Thailand,95 are examples of this process. If, concomitantly with monetization, commercialization also proceeds apace, there is increasing division of labor, which creates a demand for larger cash balances to bridge payments and receipts. Likewise, there will be an increase in cash balances owing to the replacement of savings in kind by monetary savings, which also helps to increase the marketed surplus from the subsistence sector. This also demonstrates another type of feedback interaction between monetization and commercialization. But the net increase in the demand for money from monetization per se would be much smaller, compared with the demand arising from an increase of economic activity in the monetized sector because of the higher levels of economic activity in the monetized sector. However, in practice it would be difficult to disaggregate the increase between these two components of the rise in the demand for cash balances.

It would be realistic to expect the velocity of money to be lower in the less sophisticated, newly monetized sector than in the existing monetized sector, and, consequently, the usual impact of an increase in the rate of monetization of an economy, ceteris paribus, would be to lower the overall velocity of money. But it is difficult empirically to separate the velocity of circulation of money in the newly monetized sector from the existing monetized sector, particularly because monetization affects transactions rather than sectors.

Emery and Aghevli made different types of attempt to estimate the magnitude and effects of monetization.

Emery attempted to estimate the rate of monetization as a residual (on the assumption that income velocity remains constant) using the following equation: 96

VV(rate of monetization)=MMPPOO

This implies that the rate of monetization will be equal to the rate of change in the money stock (M) less the rate of change in prices (P) less the rate of change in real output (0). This method of estimating the rate of monetization does not produce logical or plausible results, mainly because the velocity of money does not remain stable, and unless one can separate velocity and monetization (which is impossible at present), constructing a specific equation to estimate the rate of monetization appears to be a hopeless task.97

Aghevli attempted to study the effects of monetization on the demand for money by using the number of banks per capita as a proxy for monetization.98 This is, however, not a suitable proxy, because the number of banks has no logical or empirical relationship to the rate of absorption of the subsistence sector into the monetary sector. It is basically a measure of institutional banking development; even from this point of view, the number of banking accounts per capita would seem to be a more meaningful indicator. The argument that as banking facilities become more readily available they decrease the costs of monetary as opposed to nonmonetary transactions, and increase the demand for real balances,99 does not indicate whether the monetary transactions are necessarily mediated through bank deposits rather than through currency. Even as a measure of banking development, the number of banking offices per capita is not very informative unless supplemented by details of the conditions for entry of new banks and/or expansion of existing banks. If there are restrictions on new banks or branches, this proxy has even more limited significance.

The preceding analysis brings us to a consideration of the rate of monetization as an ex ante variable (derived from the ex post magnitudes in the national accounts time series) in financial programming. To the extent that the nonmonetized sector is covered in the national accounts, it would be double counting to allow for an additional monetization factor in estimating the optimal rates of growth of money supply. For instance, the assumption of an annual rate of monetization of 1 per cent (on the basis of successive rounds of the National Sample Survey), which is commonly used in monetary projections in India, does not allow for the monetization already embedded in the national accounts.100 However, if there is presumptive evidence of underestimation of the nonmonetized sector in the national accounts, it would be legitimate to allow for additional monetization, on analytic and judgmental bases, in financial programming. Moreover, monetization is a discontinuous process. For instance, while the monetization ratio for Papua New Guinea shows a rise of 12 percentage points over the period 1966–74, the rise itself was irregular. It leveled off at 0.71 in 1967–69 and 0.77 in 1971–72. Given its discontinuity, it would be questionable to assume a constant rate of monetization, except for statistical convenience,101 since it would be awkward to postulate a varying rate for projections.

But even more pertinent than the constancy assumption is the relevant time horizon that should be allowed for monetization. Since monetization is essentially a structural phenomenon, its significance is naturally bound to decline over time;102 it is more relevant for medium-term and long-term financial programming than for short-term (one-year) programs. Monetization would be a significant determinant of the demand for money, and hence a relevant programming variable, in economies that still have a substantial subsistence sector and are therefore likely to undergo further monetization, such as those in Southeast Asia, the South Pacific, or tropical Africa. Once an economy has reached the critical threshold at which monetization becomes an asymptote, one cannot really assume any further increase in monetization as a determinant for the demand for money. The prospective trend of monetization in the LDCs would depend on the net outcome of opposing tendencies in the main components of nonmonetary income. Thus, one may assume, in the absence of countervailing official policy, a decline of the consumption of home-produced goods in agriculture, sharecropping, and household industries, which would together accelerate monetization.103 But the nonmonetized element may also become more important with the growth of consumer durables and financial services.

Given the inadequacy of national accounts data on monetization, recourse may be had to a suitable proxy, such as the marketed surplus of major food crops.104 But “in the absence of an independent proxy to capture the monetisation effect, the income elasticity [of the demand for money] will be biased upwards.” 105 The upward bias of the estimated income elasticity of the demand for money may be accentuated to the extent that prospective monetization will be at a lower pace than recently in such countries as Indonesia.106

portfolio behavior of economic sectors

The effects of monetization on the portfolio behavior of households and financial institutions would be governed by its effects on the distribution as well as the composition of monetary aggregates. But it is difficult to determine the quantitative distribution of the increase in money supply as a result of monetization between different sectors and financial intermediaries. Some qualitative judgments can, however, be made regarding the impact of monetization on the composition of monetary aggregates. Thus, given the high ratio of currency to money supply in most LDCs (Table 15), the inadequacy of banking facilities, and the backwardness of the banking habit, the short-run impact of monetization on the composition of money supply is more likely to be an increase in the demand for currency rather than increased bank deposits. This is so because the transition from transactions in kind to transactions in currency is psychologically and institutionally easier than that from barter to bank money, which involves a quantum jump in institutional and behavioral patterns. But, again, it is not possible to distinguish the increase in currency attributable to monetization from the increase originating from the already monetized sector.107 Therefore, it is not surprising that even otherwise comprehensive studies have not been able to assess the quantitative effects of monetization on the demand for currency and on the trend of the ratio of currency to money supply. It is also not possible to draw any inferences regarding the trend of monetization from time series of annual absorption or return of currency (notes and coins),108 since this may or may not be connected with the extent to which monetary transactions are being substituted for transactions in kind.

Table 15.

Asian Countries: Ratiosof Currencyto Money Supply

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Source: All series are quarterly and are taken from the Data Fund of the International Monetary Fund.

Ratio of currency to narrow money, seasonally adjusted series.

Ratio of currency to broad money, seasonally adjusted series.

First quarter of beginning year-fourth quarter of closing year.

Fourth quarter of beginning year-fourth quarter of closing year.

First quarter of beginning year-third quarter of closing year.

Since typically the nonmonetized sector is predominantly rural, the impact of monetization would be largely reflected in a reduction of the element of consumption of home-produced agricultural goods. The concomitant transformation of real into financial savings and its effects on the composition of money supply would depend on the typical portfolio behavior of rural households. Since savings banks tend to be more widespread in rural areas than are commercial banks (and also given the greater expense and sophistication of checking accounts), the choice of assets would in most cases not be between currency and demand deposits as much as between currency and savings deposits. Thus, the immediate impact of monetization in rural areas would be primarily on currency holdings and secondarily on the deposit base of the savings banks. But even if rural banks become active lenders, the credit multiplier is likely to be smaller because of the high internal cash drain arising from the predominance of cash rather than check withdrawals. An attempt has been made to develop a framework to analyze qualitative and quantitative aspects of monetization in some Southeast Asian countries (Chart 7).109 But a major problem in testing such hypotheses is that the transition to different types of monetization, as well as the quantification on the horizontal scale, is invariably concurrent rather than sequential. Since there is no determinate transmission mechanism between monetization and the degree and composition of financial intermediation, it is difficult to generalize even on the direction of impact of initial monetization on the portfolio behavior of financial institutions. Consequently, one cannot argue that monetization will necessarily lead to, say, increased absorption of government debt, which is more a function of the breadth and activity of capital markets.110

Chart 7.

Selected Southeast Asian Countries: Qualitative and Quantitative Aspects of Monetization

Source: Ungku A. Aziz, “Financing Agricultural Production and Marketing,” SEANZA Lectures: Lectures Delivered at the Seventh SEANZA Central Banking Course Held in Colombo 3 July-12 September, 1968 (Central Bank of Ceylon, 1968), p. 221.

fiscal policy

The fiscal implications of monetization may originate through one or more channels. First, taxable capacity is determined by the degree of monetization, since it is generally feasible to tax only economic agents whose economic activity is monetized and who can therefore pay taxes in money. It is difficult to determine the quantity and value of subsistence output for tax and other fiscal purposes. To the extent that monetization enlarges taxable capacity, it is clearly pertinent to take account of its fiscal impact. Second, the nonmonetized sector per se poses specific fiscal issues. Thus, an undiscriminating fiscal policy may affect the economic incentives of the subsistence sector.111 Similarly, the component of “in-kind” consumption in the nonmonetized sector determines the effective incidence of taxation.112

There has been no systematic investigation of the precise impact of monetization on taxable capacity. One study attempted to measure this effect by using the per capita holdings of (a) coins and notes; (b) coins, notes, and demand deposits; and (c) coins, notes, demand deposits, and time deposits as the monetization variables (expressed in U. S. dollars) divided by the population.113 The results showed that the equation using the narrowest definition of money was the most highly significant among the three proxies for monetization and also when calculated with per capita income. But this study does not really substantiate the impact of monetization on tax performance because the per capita holdings of money—regardless of how money is defined—give no clue to the rate of absorption of the nonmonetized into the monetized sector. It is also difficult to separate the changes in per capita holdings of money into those arising from monetization and those arising from the already monetized sector. The currency component is also susceptible to purely autonomous factors that might reflect, for instance, changes in payment habits and banking development rather than in the degree of monetization. Moreover, as Lotz and Morss recognize, “some citizens hold larger amounts of cash than is necessary from a taxation viewpoint.” 114 This is a crucial weakness of the proxy based on the narrowest definition of money (coins and notes), inasmuch as the tax component of the demand for cash balances is comparatively much smaller than the really significant determinants, such as the expected real income per capita and the expected net rate of interest paid on bank deposits.115

The implications of in-kind consumption for the effective incidence and on the overall progressivity of the tax structure are also pertinent to assessing the fiscal implications of monetization. Since only money income is taxed (directly or indirectly) and in-kind consumption (which is not taxed) is part of income, which is very significant in most rural areas, the tax system in such countries tends to be both progressive and biased toward the urban sector.116 The main conclusions of Huang’s study were that the exclusion of in-kind consumption from (a) direct taxation accentuates the progressive character of individual income taxes and from (b) indirect taxation eliminates a large part of the income of the subsistence sector from taxation, thereby increasing the overall progressivity of the tax structure. Since in-kind income and consumption are more common in rural areas where incomes are lower than in urban areas, the tax burden for both sectors combined would be more progressive. The exclusion of in-kind consumption is partly responsible for the implied progressivity of indirect taxes. The progressivity would be substantially reduced if in-kind consumption were in fact taxed, particularly on the basis of consumption of alcoholic, tobacco and food products, and miscellaneous expenditures. Huang’s analysis suggests that unless the tax structure and rates are changed along with the monetization of in-kind income, indirect taxes will become more regressive over time.

VII. Monetization—Toward a Paradigm and an Agenda

In the light of the preceding survey and analysis, this section suggests a possible conceptual model and an agenda for future research for analyzing and measuring monetization and its bearing on financial and monetary policies in the LDCs.

A reasonably adequate model of monetization, incorporating its more significant explanatory variables in a typical developing economy, could be formulated somewhat on the following lines.

Mr = f (Mks, Mc, Ml Msc, Md, Mm)

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From analytical reasoning and available empirical evidence, we expect


The quantification of such a model would require an adequate time series for all the relevant explanatory variables, or proxies. Since the object is not only to arrive at the most comprehensive macroeconomic indicator of monetization but also to analyze its implications for monetary and financial policy, research would need to focus on national accounts, monetary analysis, and portfolio behavior. This would involve an appropriately disaggregated structure of national accounts with constant-value time series of the ratios of the nonmonetized sector to total GNP. This would help to establish the rate of monetization, which could then be used for financial programming and policies. It is also important to analyze the impact of monetization on the structure and composition of monetary variables (currency, bank deposits, etc.) and the portfolio behavior of households and financial institutions and of the informal financial sector.

Since nonmonetary imputations to a varying degree are already incorporated in the national accounts of the LDCs, it should be feasible to separate the monetized and nonmonetized sectors. As with other basic economic statistics, such as government finance, money and credit, and the balance of payments, the degree of disaggregation has to be determined on grounds of its costs and utility for policy-making purposes. The endeavor should be to adapt existing systems of national accounts toward this end, and to ensure general compatibility with the SNA 117 and the International Standard Industrial Classification of all Economic Activities. The case for more comprehensive coverage of the nonmonetized sector in national accounts has been strongly endorsed by the United Nations and various regional working groups.118

To facilitate the construction of the essential building blocks for the nonmonetized sector in the national accounts, there should be a properly designed program of stratified random multipurpose sample surveys of household budgets (for determining the nonmonetized component of rural or urban consumption on the lines of the surveys in India and Indonesia), of rural credit (as in India and Nepal), of the marketed surplus of agricultural food crops, and of own-account capital formation. Once the trend of the monetization ratio is established, it would be interesting to analyze (using such techniques as factor analysis)119 its relationship to other major economic and social variables (such as per capita income) that reflect growth and development.

VIII. Conclusions

This paper has attempted, in the light of a critical review of the concepts and the empirical evidence, to develop a conceptual framework and an agenda for further research on analyzing and measuring monetization.

Monetization tends to be used as a portmanteau concept in the literature, but it should properly be defined as the enlargement of the sphere of the money economy through the absorption of the nonmonetized sector, and should be clearly differentiated from commercialization and financial intermediation. Since there is no pure subsistence sector, the nonmonetized sector should be understood to be strictly a statistical aggregate of the imputations to nonmonetized transactions. Its economic rationale derives from the search by rural households for survival rather than maximizing algorithms in an environment of high risk and uncertainty. Consequently, developing economies may need to adopt a conscious policy aimed at an optimal rate of monetization to maximize the welfare and development potential of the subsistence sector.

The most meaningful measure of aggregate monetization is the monetization ratio, which is the proportion of aggregate goods and services in an economy that are paid for in money by the purchaser. Consequently, to capture the level and trend of monetization, one must show the relative shares of the monetized and nonmonetized sectors in the national accounts at constant prices. Such data are currently not available for most LDCs. Among the notable exceptions are Papua New Guinea and Tonga, particularly Tonga, which has possibly the most highly disaggregated of national accounts among the LDCs. Historically, monetization has been an evolutionary, albeit discrete, process. It tends to assume an asymptotic character after a certain critical threshold, which varies between different economies. But it is a relevant ex ante variable for financial programming in economies where there is still a substantial nonmonetized sector, as in Southeast Asia, the South Pacific region, and tropical Africa. Since there is no determinate transmission mechanism between monetization and financial intermediation, it is difficult to measure the direction and magnitude of the impact of first-round monetization on the portfolio behavior of households and financial institutions. But, since the probable initial impact of monetization is more likely to be on currency balances than on bank deposits, a close analysis of the temporal and regional behavior of the currency ratio and the pattern of debits to bank deposits would be rewarding. The fiscal implications of monetization are relevant insofar as tax policy affects the incentives of the subsistence sector. Similarly, the component of nonmonetized consumption determines the effective incidence of taxation. Consequently, tax structure and rates would need to be appropriately modified in keeping with the pace and direction of monetization.

There is, however, a real need for detailed research on the structure and behavior of the nonmonetized sector as well as the nature and effects of monetization on crucial variables, such as the marketed surplus of major subsistence sectors, the portfolios of households, and financial institutions. The program should aim, among other things, at an appropriately disaggregated system of national accounts and should stimulate multidisciplinary studies, straddling monetary and development economics as well as economic anthropology. On the whole, the role of monetization in monetary policy and programming and in development strategy would seem to be far more important than has been recognized so far in conventional economics.


Table 16.

Asian Countries: Coverageof Nonmonetized Sectorin National Accounts

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Sources: For continental Asian region: Adapted from Derek W. Blades, Non-Monetary (Subsistence) Activities in the National Accounts of Developing Countries, Development Centre, Organization for Economic Cooperation and Development (Paris, 1975), p. 14. For South Pacific region: Fiji, obtained from Government Statistician, Suva; Papua New Guinea, Bureau of Statistics, National Accounts Statistics, 1960–74 (Port Moresby), p. 15; Tonga, Statistics Office, Ministry of Finance, Nuku’alofa, Statistical Abstract, 1972 (cited in Estimating Non-Monetary Economic Activities in the text, footnote 51), p. 34.

indicates coverage in the country’s present national accounts series.

indicates not covered or not known.

Land clearance, boreholes, roads, and bridges.

Includes crop storage in Bangladesh.

Covers own-account production of food and expansion of food gardens used for own-account

Collection of firewood.

Construction of equipment for use in production for own-consumption (e.g., canoes).

Community, social, and personal services.

Table 17.

Papua New Guinea: Marketand Nonmarket Componentsof Gross Domestic Product (GDP) and Expenditure, 1961–74

(In millions of kina at current purchasers’ value)

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Source: Derived from Bureau of Statistics, National Accounts Statistics, 1960–74 (Port Moresby).