Financial Dependence and Growth

Abstract

This paper examines whether financial development facilitates economic growth by scrutinizing one rationale for such a relationship; that financial development reduces the costs of external finance to firms. Specifically, we ask whether industrial sectors that are relatively more in need of external finance develop disproportionately faster in countries with more developed financial markets. We find this to be true in a large sample of countries over the 1980s. We show this result is unlikely to be driven by omitted variables, outliers, or reverse causality. (JEL O4, F3, G1) A large literature, dating at least as far back as Joseph A. Schumpeter (1911), emphasizes the positive influence of the development of a country's financial sector on the level and the rate of growth of its per capita income. The argument essentially is that the services the financial sector provides -- of reallocating capital to the highest value use without substantial risk of loss through moral hazard, adverse ...