Financial Sector Development and Total Factor Productivity Growth

Abstract

Recent years have witnessed important structural changes around the world as a result of the globalization process, the creation of new economic blocks and the liberalization of the financial sector in many countries. In view of this, many sectors of the industrialized countries have gone through major deregulatory changes to acclimatize themselves to new environments. At the same time, many countries have undertaken institutional reforms to build a market-orientated financial system in the hope that transition towards a market economy will improve productivity. These changes often tend to distort the markets (in the short run), thereby affecting the allocation of resources. Furthermore, in the face of uncertainty resulting from changes in regulatory structure and the development of financial institutions to foster market economy, many countries might not be able to achieve their maximum growth potential. In other words, productivity growth is likely to depend on the development of financial institutions and the stage of economic development. That is, a less developed country is likely to benefit more (in terms of output growth rate) from development of financial institutions than a developed economy that has well-functioning and sound financial institutions.