Finance and Economic Development

Abstract

This chapter reviews the literature on finance and economic development. It starts with a description of the roles of finance, a definition of financial efficiency, and a discussion of whether countries may have financial sectors that are ‘too large’ compared to the size of the domestic economy. Next, the author describes several indicators of financial development and reviews the literature on the relationship between financial development and economic growth. In the literature review, he discusses in detail some recent evidence indicating that the marginal contribution of financial development to gross domestic product (GDP) growth becomes negative when credit to the private sector reaches 110 per cent of GDP. The chapter concludes with some policy conclusions targeted to developing countries.

I would like to thank Mackie Bahrami, Gilles Carbonnier and the Editorial Board for their helpful comments and suggestions. This chapter draws on joint work with Jean Louis Arcand and Enrico Berkes (Arcand et al., 2011) and on an unpublished background paper prepared for Chapter 3 of the 2009 Trade and Development Report (UNCTAD, 2009). Thus there are some overlaps between Sections 2.2, 3.2 and 4 of this chapter and Arcand et al. (2011) and UNCTAD (2009). The views expressed in this contribution are my own and need not reflect, and should not be represented as, the views of the United Nations. The usual caveats apply.