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Financial Institutions and The Wealth of Nations: Tales of Development

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Author Info
Jian Tong ()
Chenggang Xu ()

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Abstract

Interactions between economic development and financial development are studied by looking at the roles of financial institutions in selecting R&D projects (including for both imitation and innovation). Financial development is regarded as the evolution of the financing regimes. The e?ectiveness of R&D selection mechanisms depends on the institutions and the development stages of an economy. At higher development stages a financing regime with ex post selection capacity is more e?ective for innovation. However, this regime requires more decentralized decision-making, which in turn depend on contract enforcement. A financing regime with more centralized decision-making is less a?ected by contract enforcement but has no ex post selection capacity. Depending on the legal institutions, economies in equilibrium chose regimes that lead to di?erent steady-state development levels. The financing regime of an economy also a?ects development dynamics through a ‘convergence e?ect’ and a ‘growth inertia e?ect.’ A backward economy with a financing regime with centralized decision-making may catch up rapidly when the convergence e?ect and the growth inertia e?ect are in the same direction. However, this regime leads to large development cycles at later development stages. Empirical implications are discussed.

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Paper provided by William Davidson Institute at the University of Michigan Stephen M. Ross Business School in its series William Davidson Institute Working Papers Series with number 2004-672.

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Length: 72 pages
Date of creation: 01 Apr 2004
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Handle: RePEc:wdi:papers:2004-672

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Related research
Keywords: development; transition; financial institutions; R&D;

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Find related papers by JEL classification:
O1 - Economic Development, Technological Change, and Growth - - Economic Development
O3 - Economic Development, Technological Change, and Growth - - Technological Change
O4 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity
G0 - Financial Economics - - General
P0 - Economic Systems - - General
K0 - Law and Economics - - General

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