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Financial Innovation and Endogenous Growth

Listed author(s):
  • Stelios Michalopoulos

    ()

    (Tufts University)

  • Luc Laeven

    (IMF and CEPR)

  • Ross Levine

    (Brown University and NBER)

We model technological and ?nancial innovation as re?ecting the decisions of pro?t maximizing agents and explore the implications for economic growth. We start with a Schumpeterian growth model where entrepreneurs earn pro?ts by inventing better goods and ?nanciers arise to screen entrepreneurs. A novel feature of the model is that ?nanciers also engage in the costly, risky, and potentially pro?table process of innovation: Financiers can invent more e¤ective processes for screening entrepreneurs. Every screening process, however, becomes less e¤ective as technology advances. Consequently, technological inno- vation and economic growth stop unless ?nanciers continually innovate. The model also allows for rent-seeking ?nancial innovation, in which ?nanciers engage in privately pro?table but socially ine¢ cient innovation that slows growth. Empirical evidence is more consistent with this dynamic, synergistic model of ?nancial and technological innovation than with existing theories.

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Paper provided by Institute for Advanced Study, School of Social Science in its series Economics Working Papers with number 0097.

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Length: 47 pages
Date of creation: May 2011
Handle: RePEc:ads:wpaper:0097
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