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Financial development and industrial capital accumulation

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  • Bossone, Biagio
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    Abstract

    In an economy where decisions are decentralized and made under conditions of uncertainty, the financial system can be seen as the complex of institutions, infrastructure, and instruments that society adopts to minimize the costs of trading promises when agents have incomplete trust and limited information. Building on a microeconomic general equilibrium model that portrays such fundamental financial functions, the author shows that, in line with recent empirical evidence, the development of financial infrastructure stimulates greater and more efficient capital accumulation. He also shows that economies with more developed financial infrastructure can more easily absorb exogenous shocks to output. The results call for addressing a crucial issue in the sequencing of reform in the financial sector: early in development, banks provide essential financial infrastructure services as part of their exclusive relationships with borrowers. Further economic development requires that such services be provided extrinsically to the bank-borrower relationship, clearly at the expense of bank rents. There may be a compelling discontinuity to financial sector development in that banks need to be supported early in development but to be"weakened"later - at the expense of bank rents - to foster further development. The important question for policy is when and how to generate and manage this discontinuity so that it is not forced on society by costly and traumatic events such as bank failures.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2201.

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    Date of creation: 31 Oct 1999
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    Handle: RePEc:wbk:wbrwps:2201

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    Keywords: Payment Systems&Infrastructure; Banks&Banking Reform; Economic Theory&Research; Decentralization; International Terrorism&Counterterrorism; Banks&Banking Reform; Economic Theory&Research; Financial Intermediation; Environmental Economics&Policies; Financial Crisis Management&Restructuring;

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    1. Wendy Carlin & Colin Mayer, 1999. "Finance, Investment and Growth," OFRC Working Papers Series, Oxford Financial Research Centre 1999fe09, Oxford Financial Research Centre.
    2. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
    3. Demirguc-Kunt, Ash & Levine, Ross, 1996. "Stock Markets, Corporate Finance, and Economic Growth: An Overview," World Bank Economic Review, World Bank Group, World Bank Group, vol. 10(2), pages 223-39, May.
    4. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(3), pages 225-243, September.
    5. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 110(2), pages 407-43, May.
    6. Demirguc-Kunt, Asl1 & Maksimovic, Vojislav, 1996. "Institutions, financial markets, and firms'choice of debt maturity," Policy Research Working Paper Series 1686, The World Bank.
    7. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, American Economic Association, vol. 88(3), pages 559-86, June.
    8. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1990. "The Role of Banks in Reducing the Costs of Financial Distress in Japan," NBER Working Papers 3435, National Bureau of Economic Research, Inc.
    9. Lippman, Steven A & McCall, John J, 1986. "An Operational Measure of Liquidity," American Economic Review, American Economic Association, American Economic Association, vol. 76(1), pages 43-55, March.
    10. Nicola Cetorelli, 1997. "The role of credit market competition on lending strategies and on capital accumulation," Working Paper Series, Issues in Financial Regulation, Federal Reserve Bank of Chicago WP-97-14, Federal Reserve Bank of Chicago.
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    Cited by:
    1. Ferro, Gustavo & Antón Rodríguez, Martín, 2007. "Crédito, producto y eficiencia en la producción de crecimiento
      [Credit, production and efficiency in the production of growth]
      ," MPRA Paper 15094, University Library of Munich, Germany, revised Mar 2009.
    2. Ferro, Gustavo, 2000. "¿Vale la pena tener intermediarios financieros propios? Un examen a la literatura reciente
      [Does it worth having local financial intermediaries? An examination onto recent literature]
      ," MPRA Paper 15359, University Library of Munich, Germany.

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