Sources and Effectiveness of Financial Development: What We Know and What We Need to Know

Abstract

There is a broad consensus in the finance-growth literature that, with few exceptions, there exists a positive long-run association between financial development and economic growth. This relationship is fairly robust to how financial development is measured — be it using indicators of banking or capital market development — and estimated; the latter ranging from cross-country to time-series and panel data techniques. Importantly, financial development has been shown to be one of the most robust determinants of economic growth, alongside most of the alternatives (for example, King and Levine 1993). Thus, financial development may hold the key to economic prosperity and may, consequently, be a powerful mechanism for reducing poverty worldwide.¹ As a result of this widespread consensus, the finance-growth literature has recently begun to shift its attention towards understanding why some countries have been able to develop their financial systems, while some others have not.