Global Economic Development Class

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Global Economic DevelopmentClass 17

• Questions
• What is the relationship between financial
  development and growth? Today
• What are the determinants of financial
  development?
• Next class trust and its determinants

2

• Question does financial development causes
  economic growth?
• Problem endogeneity. There is correlation, but
  causality?
• Typical problem in growth economics
• Does human capital accumulation causes growth,
  or growth causes human capital accumulation
• Does stable politics causes growth, or growth
  causes stable politics
• Does low inequality causes growth, or growth
  causes low inequality
• Does a reduction of fertility causes growth, or
  growth causes a reduction in fertility
• Does better institutions causes growth, or
  growth causes better institutions.
• Challenge break the endogeneity. Find an
  ingenious method to determine direction of
  causality! Both papers of today try to do that.

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• Rajan and Zingales Financial Dependence and
  Growth
• Idea of paper
• Assume financial development causes growth.
  That is, without financial development, growth
  will not happen (this means that financial
  development is necessary condition for growth,
  but not necessarily sufficient).
• Take industries that need more external funds to
  grow (because of technological conditions)
  Compare drug industry with tobacco industry.
  This need is equal across countries but differs
  across industries.
• Take a measure of financial development across
  countries.
• Then, if our assumption is true, in a specific
  country, industries with more external financial
  needs should grow faster than industries with
  less external financial needs, if the country is
  financially developed. If the country is not
  financially developed then, it would not matter.

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• Main Equation
• Growthj,k constant country indicators
  industry indicators
• beta1 (industry js share of manufacturing in
  country k in 1980)
• beta2 (external dependence of industry j
  financial development of country k)
• ejk
• Some issues
• Why only manufacturing?
• Why they include the industry share?

5

• Table 1 External dependence and capital
  expenditures across industries in US in 1980s
• Measures of financial development
• Domestic credit stock market capitalization
• Domestic credit to private sector
• Accounting standards
• Table 2 Measures of financial development
• Results
• Table 4 Main results
• Example Machinery and Beverages in Italy and
  Philippines.
• Table 5 An example

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• Fisman and Love Financial development and
  intersectoral allocation A new approach
• Similar to previous, but another ingenious idea
• Assume that financial development affects growth
• Take growth of industries in countries
• Then the correlation between growth of
  industries in two countries should be higher if
  both countries are financially developed
• Moreover, the correlation should be stronger if
  the pairs compared are at the same level of
  development (in authors jargon same growth
  opportunities)
• Main equation
• Corr(Growthic,Growtid)alphaf(FDc,FDd) ecd
• Results
• Tables 4 and 5

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• Conclusions
• Financial development causes growth
• Not clear how much growth can be attributed to
  financial development
• A calibrated model may be necessary to answer
  the previous question compare the growth results
  with a without financial development
• In this sense, regression analysis guides us in
  the right direction, but it is not very precise
• Overall, no country that wants to grow should
  neglect the development of the private financial
  sector
• This takes us to next question what are the
  determinants of financial development? And how to
  construct a developed financial sector?