More on Finance and Growth: More Finance, More Growth?

By Ross Levine. 2003

477 citations recorded by the source corpus.

JULY/AUGUST 2003 31 Nobel Prize winners disagree about the impact of the financial sector on economic growth. Some do not even consider finance worth discussing. A collection of essays by the “pioneers of development economics”—including three winners of the Nobel Prize in Economics—does not discuss finance (Meier and Seers, 1984). At the other extreme, Nobel Prize winner Merton Miller (1998, p. 14) recently remarked “that financial markets contribute to economic growth is a proposition almost too obvious for serious discussion.” As a third view, Nobel Laureate Robert Lucas (1988) holds that the role of finance in economic growth has been “over-stressed” by the growth literature. Resolving the debate about the importance of financial development for economic growth is important for distinguishing among theoretical models. More importantly, information on the importance of finance for growth will affect the intensity with which researchers and policymakers attempt to identify and construct appropriate financial sector reforms around the world. This paper selectively discusses recent empirical work on the controversial issue of whether financial systems play a critical role in determining long-run rates of economic growth. Building on work by Bagehot (1873), Schumpeter (1912), Gurley and Shaw (1955), Goldsmith (1969), and McKinnon (1973), recent research has employed different econometric methodologies and data sets to assess the role of the financial sector in stimulating economic growth. I will focus on three classes of empirical studies: (i) pure cross-country growth regressions, (ii) panel techniques that exploit both the cross-country and time-series dimensions of the data, and (iii) microeconomic-based studies that examine the mechanisms through which finance may influence economic growth. Thus, I will largely ignore country case studies and purely time-series investigations, which generally confirm the conclusions from the cross-country, panel, and microeconomic-based studies. Also, this paper does not discuss the theory surrounding the role of financial contracts, markets, and intermediaries in economic growth.1 The growing body of empirical research, using different statistical procedures and data sets, produces remarkably consistent results. First, countries with better-developed financial systems tend to grow faster—specifically, those with (i) large, privately owned banks that funnel credit to private enterprises and (ii) liquid stock exchanges. The levels of banking development and stock market liquidity each exert a positive influence on economic growth. Second, simultaneity bias does not seem to be the cause of this result. Third, better-functioning financial systems ease the external financing constraints that impede firm and industrial expansion. Thus, access to external capital is one channel through which financial development matters for growth because it allows financially constrained firms to expand. Each of the different statistical procedures that have been brought to bear on the finance-growth debate has methodological shortcomings, which emphasizes the need for additional research to clarify the relationship between finance and growth. Moreover, data problems plague the study of finance and growth in general. Perhaps the biggest data problem involves the empirical proxies of “financial development,” because it is difficult to construct accurate, consistent measures of financial development for a broad cross-section of countries. Thus, more microeconomic-based studies that explore the possible channels through which finance influences growth will foster a keener understanding of the finance-growth nexus. Without ignoring the weaknesses of existing work and the need for future research, the consistency of existing empirical results across different data sets and statistical procedures suggests that finance plays an important role in the process of economic growth. The body of existing work motivates research

Subfields: Economics and Econometrics, Finance, Information Systems

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Citations in the corpus

Natural resources, financial development and institutional quality in Africa: Is there a resource curse? (2018, background): “…in literature is surprising given that it is now widely accepted that financial development constitutes a potentially important mechanism for long run growth (Levine, 2003; Demetriades and Andrianova, 2004; Goodhart, 2004) hence the need to examine the impact of natural resources on this sector.”
Institutional quality thresholds and the finance Growth nexus. (2013, background): “1 Levine (2003) provided an excellent overview of a large body of empirical literature that suggests that financial development can robustly explain differences in economic growth across countries.”
Mobile Phones, Financial Inclusion, and Growth (2012, background): “Levine (2003) points out that access to external capital is one channel through which financial development matters for growth because it allows financially constrained firms to expand.”
Financial development, institutional investors, and economic growth (2017, background): “Many studies support the concept that a positive relationship exists between financial development indicators and economic growth (e.g., Beck & Levine, 2004; Beck, Levine, & Loayza, 2000; King & Levine, 1993; Levine, 1997, 2003; Levine, Loayze, & Beck, 2000; Rajan & Zingales, 1998).”
Finance and Growth: What we Know and What we Need to Know (2004, background): “In his recent review of the literature on finance and growth, Levine (2003) suggests that raising DEPTH from the mean of the slowest growing quartile of countries to the mean of the fastest growing quartile, would have increased growth by almost 1 percent per year.”
Regulations, competition and bank risk-taking in transition countries (2008, background): “Levine (2003) discusses that, in general, powerful official supervisors could improve”
Trade Openness, Capital Flows and Financial Development in Developing Economies (2009, background): “…economic literature has long maintained that a well-developed financial system is a vital prerequisite to economic growth (King & Levine, 1993a, b; Levine, 1997, 2003; Demirguc-Kunt & Maksimovic, 1998; Rajan & Zingales, 1998; Darrat, 1999; Dritsakis & Adamopoulos, 2004; Demetriades & Andrianova,…”
Does too much finance harm economic growth (2014, methodology): “1 Levine (2003) provides an excellent overview of a large body of empirical literature that suggests that financial development can robustly explain differences in economic growth across countries.”
Nonlinear dynamics of the finance-inequality nexus in developing countries (2012, background): “1 Levine [ 19 ] provided an excellent overview of a large body of empirical literature that suggests that financial development can robustly explain differences in economic growth across countries.”
Financial Development and Openness: Evidence from Panel Data (2009, unknown): “It is now widely accepted that financial development constitutes a potentially important mechanism for long-run growth (Levine, 2003; Demetriades and Andrianova 2004; Demetriades and Hussein, 1996; Goodhart, 2004).”
The impact of bank regulations, concentration, and institutions on bank margins (2003, methodology): “…research does not find countervailing benefits from regulatory restrictions on bank entry, activities, or freedom in terms of bank stability, firms’ access to external finance, or overall financial development (Beck, Demirguc-Kunt, and Levine, 2003a,b; Barth, Caprio, and Levine, 2003).”
The economic value of regulated disclosure: Evidence from the banking sector (2006, methodology): “Legal origin has also been extensively used as an instrument in the finance-growth literature (see Levine, 2003) as well as in the banking crises literature (see, e.g., Barth et al., 2004).”