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Financial Innovation and Endogenous Growth

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  • Levine, Ross
  • Laeven, Luc
  • Michalopoulos, Stelios

Abstract

We model technological and financial innovation as reflecting the decisions of profit maximizing agents and explore the implications for economic growth. We start with a Schumpeterian endogenous growth model where entrepreneurs earn monopoly profits by inventing better goods and financiers arise to screen entrepreneurs. A novel feature of the model is that financiers also engage in the costly, risky, and potentially profitable process of innovation: Financiers can invent more effective processes for screening entrepreneurs. Every existing screening process, however, becomes less effective as technology advances. Consequently, technological innovation and, thus, economic growth stop unless financiers continually innovate. Historical observations and empirical evidence are more consistent with this dynamic model of financial innovation and endogenous growth than with existing models of financial development and growth.

Suggested Citation

  • Levine, Ross & Laeven, Luc & Michalopoulos, Stelios, 2009. "Financial Innovation and Endogenous Growth," CEPR Discussion Papers 7465, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7465
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    Keywords

    Corporate finance; Economic growth; entrepreneurship; Financial institutions; Invention; Technological change;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

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