Working Paper: NBER ID: w5758
Authors: Raghuram G. Rajan; Luigi Zingales
Abstract: Does finance affect economic growth? A number of studies have identified a positive correlation between the level of development of a country's financial sector and the rate of growth of its per capita income. As has been noted elsewhere, the observed correlation does not necessarily imply a causal relationship. 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.
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JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial development (O16) | economic growth (O49) |
| financial development (O16) | reduce costs of external finance (G32) |
| reduce costs of external finance (G32) | faster growth in industries dependent on external financing (D25) |
| financial development (O16) | faster growth in industries dependent on external financing (D25) |
| industries generating substantial cash flow (L99) | grow faster in countries with underdeveloped financial systems (O16) |