Abstract
The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Summary of WP/92/101
“Financial Development and Economic Growth” by José De Gregorio and Pablo E. Guidotti
Ever since the pioneering contributions of Goldsmith (1969), McKinnon (1973), and Shaw (1973), the relationship between financial development and economic growth has remained an issue of debate. Numerous theoretical and empirical studies have dealt with different aspects of this relationship. This paper re-examines the empirical relationship between financial development and long-run growth by using the ratio of bank credit to the private sector to GDP as an indicator of financial development. It argues that this indicator has a clear advantage over real interest rates or monetary aggregates such as Ml, M2, or M3 in that it represents accurately the actual volume of funds channeled to the private sector. The paper also reviews measurement issues and surveys the analytical literature on economic growth and financial development.
Section III comprises an empirical investigation using different data sets. First, by including its proxy for financial development as an explanatory variable, the paper extends Barro’s (1991) cross-country growth regressions for a sample of 98 countries during 1960-85. In order to check the robustness of the paper’s results, De Long and Summers’ (1991) data set is also used. Second, using De Gregorio’s (1992a) panel data for 12 Latin American countries during 1950-85, the paper explores the relationship between financial intermediation and growth in Latin America.
The paper’s main findings are as follows: First, using Barro’s (1991) data set, the paper finds its measure of financial development to have a significantly positive effect on the long-run growth of real per capita GDP. Second, it finds the impact of financial intermediation on growth to be mainly the result of its impact on the productivity rather than the volume of investment. Third, when it examines the relationship between financial intermediation and economic growth in Latin America, the paper finds a robust and significant negative correlation between these two variables. This effect, which may appear puzzling, is interpreted in light of the extreme experiments of financial liberalization that were witnessed by Latin America during the 1970s and 1980s.
A simple model is used to illustrate how, in the absence of proper regulation, more financial intermediation may be associated with a lower efficiency of investment. The paper concludes that the positive relationship between financial development and economic growth may be reversed in the presence of unregulated financial liberalization and expectations of government bailouts.