IDEAS home Printed from https://ideas.repec.org/p/fip/fedrwp/10-05.html
   My bibliography  Save this paper

Quantifying the impact of financial development on economic development

Author

Listed:
  • Jeremy Greenwood
  • Juan M. Sanchez
  • Cheng Wang

Abstract

How important is financial development for economic development? A costly state verification model of financial intermediation is presented to address this question. The model is calibrated to match facts about the U.S. economy, such as intermediation spreads and the firm-size distribution for the years 1974 and 2004. It is then used to study the international data, using cross-country interest-rate spreads and per-capita GDP. The analysis suggests a country like Uganda could increase its output by 140 to 180 percent if it could adopt the world's best practice in the financial sector. Still, this amounts to only 34 to 40 percent of the gap between Uganda's potential and actual output.

Suggested Citation

  • Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Quantifying the impact of financial development on economic development," Working Paper 10-05, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:10-05
    as

    Download full text from publisher

    File URL: http://www.richmondfed.org/publications/research/working_papers/2010/wp_10-05.cfm
    Download Restriction: no
    File URL: http://www.richmondfed.org/publications/research/working_papers/2010/pdf/wp10-05.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Rui Castro & Gian Luca Clementi & Glenn Macdonald, 2009. "Legal Institutions, Sectoral Heterogeneity, and Economic Development," Review of Economic Studies, Oxford University Press, vol. 76(2), pages 529-561.
    2. Francisco J. Buera & Joseph P. Kaboski & Yongseok Shin, 2011. "Finance and Development: A Tale of Two Sectors," American Economic Review, American Economic Association, vol. 101(5), pages 1964-2002, August.
    3. Rajnish Mehra & Edwarad C Prescott & Facundo Piguillem, 2007. "Intermediated Quantities and Returns," Levine's Bibliography 122247000000001580, UCLA Department of Economics.
    4. Francesco Caselli & Nicola Gennaioli, 2013. "Dynastic Management," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 971-996, January.
    5. Diego Restuccia & Richard Rogerson, 2008. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 707-720, October.
    6. Mahmoud Haddad & Sam Hakim, 2015. "Can Banks Lead the Economic Recovery of the Arab Spring?," Working Papers 965, Economic Research Forum, revised Nov 2015.
    7. Robert M. Townsend & Kenichi Ueda, 2010. "Welfare Gains From Financial Liberalization," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(3), pages 553-597, August.
    8. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, vol. 100(4), pages 1875-1891, September.
    9. Greenwood, Jeremy & Jovanovic, Boyan, 1990. "Financial Development, Growth, and the Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1076-1107, October.
    10. Nezih Guner & Gustavo Ventura & Xu Yi, 2008. "Macroeconomic Implications of Size-Dependent Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 721-744, October.
    11. Carol A. Corrado & Charles R. Hulten & Daniel E. Sichel, 2006. "Intangible Capital and Economic Growth," NBER Working Papers 11948, National Bureau of Economic Research, Inc.
    12. Conesa, Juan Carlos & Krueger, Dirk, 2006. "On the optimal progressivity of the income tax code," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1425-1450, October.
    13. Ranasinghe, Ashantha, 2017. "Property rights, extortion and the misallocation of talent," European Economic Review, Elsevier, vol. 98(C), pages 86-110.
    14. Harold L. Cole & Jeremy Greenwood & Juan M. Sanchez, 2016. "Why Doesn't Technology Flow From Rich to Poor Countries?," Econometrica, Econometric Society, vol. 84, pages 1477-1521, July.
    15. Beck, Thorsten & Demirguc-Kunt, Asli & Maksimovic, Vojislav, 2006. "The influence of financial and legal institutions on firm size," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 2995-3015, November.
    16. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, May.
    17. Stephane Verani, 2018. "Aggregate Consequences of Dynamic Credit Relationships," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 44-67, July.
    18. Shushu Li & Jinglan Zhang & Yong Ma, 2015. "Financial Development, Environmental Quality and Economic Growth," Sustainability, MDPI, Open Access Journal, vol. 7(7), pages 1-22, July.
    19. Kerl, Cornelia & Niepmann, Friederike, 2014. "What determines the composition of international bank flows?," Staff Reports 681, Federal Reserve Bank of New York.
    20. Carlos Viana de Carvalho & Eduardo Zilberman & Laura Candido de Souza & Nilda Mercedes Cabrera Pasca, 2014. "Macroeconomic Effects of Credit Deepening in Latin America," Textos para discussão 629, Department of Economics PUC-Rio (Brazil).
    21. Emilio Espino & Juan M. Sanchez, 2010. "Risk sharing, investment, and incentives in the neoclassical growth model," Economic Quarterly, Federal Reserve Bank of Richmond, issue 4Q, pages 399-416.
    22. Andres Erosa & Ana Hidalgo, 2005. "On Capital Market Imperfections as a Source of Low TFP and Economic Rents," Working Papers tecipa-200, University of Toronto, Department of Economics.
    23. Rajnish Mehra & Facundo Piguillem & Edward C. Prescott, 2011. "Costly financial intermediation in neoclassical growth theory," Quantitative Economics, Econometric Society, vol. 2(1), pages 1-36, March.
    24. Era Dabla-Norris & Yan Ji & Robert M. Townsend & D. Filiz Unsal, 2015. "Distinguishing Constraints on Financial Inclusion and Their Impact on GDP, TFP, and Inequality," NBER Working Papers 20821, National Bureau of Economic Research, Inc.
    25. Ranasinghe, Ashantha & Restuccia, Diego, 2018. "Financial frictions and the rule of law," Journal of Development Economics, Elsevier, vol. 134(C), pages 248-271.
    26. Rui Castro & Gian Luca Clementi & Glenn MacDonald, 2004. "Investor Protection, Optimal Incentives, and Economic Growth," The Quarterly Journal of Economics, Oxford University Press, vol. 119(3), pages 1131-1175.
    27. Julian Neira, 2015. "Bankruptcy and Cross-Country Differences in Productivity," Discussion Papers 1511, University of Exeter, Department of Economics.
    28. repec:red:issued:17-216 is not listed on IDEAS
    29. Barro, Robert J & Lee, Jong-Wha, 2001. "International Data on Educational Attainment: Updates and Implications," Oxford Economic Papers, Oxford University Press, vol. 53(3), pages 541-563, July.
    30. Boyd, John H. & Prescott, Edward C., 1986. "Financial intermediary-coalitions," Journal of Economic Theory, Elsevier, vol. 38(2), pages 211-232, April.
    31. Siegel, Jeremy J., 1992. "The real rate of interest from 1800-1990 : A study of the U.S. and the U.K," Journal of Monetary Economics, Elsevier, vol. 29(2), pages 227-252, April.
    32. Carlos Viana de Carvalho & Eduardo Zilberman & Laura Candido de Souza & Nilda Mercedes Cabrera Pasca, 2014. "Macroeconomic Effects of Credit Deepening in Latin America," Textos para discussão 629, Department of Economics PUC-Rio (Brazil).
    33. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
    34. Cândida Ferreira, 2013. "Bank performance and economic growth: evidence from Granger panel causality estimations," Working Papers Department of Economics 2013/21, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    35. Andres Erosa, 2001. "Financial Intermediation and Occupational Choice in Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 303-334, April.
    36. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
    37. Mutreja, Piyusha, 2016. "Composition of Capital and Gains from Trade in Equipment," MPRA Paper 74908, University Library of Munich, Germany.
    38. Timothy Kehoe & Sewon Hur & Kim Ruhl & Jose Asturias, 2015. "The Interaction of Entry Barriers and Financial Frictions in Growth," 2015 Meeting Papers 792, Society for Economic Dynamics.
    39. repec:eee:jmacro:v:54:y:2017:i:pb:p:393-409 is not listed on IDEAS
    40. Era Dabla-Norris & Yan Ji & Robert M. Townsend & Filiz D Unsal, 2015. "Identifying Constraints to Financial Inclusion and Their Impact on GDP and Inequality; A Structural Framework for Policy," IMF Working Papers 15/22, International Monetary Fund.
    41. Berger, Allen N, 2003. " The Economic Effects of Technological Progress: Evidence from the Banking Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(2), pages 141-176, April.
    42. Enoch Hill & David Perez-Reyna, 2016. "Leverage away your wedge: An analysis of banks' impact on output," DOCUMENTOS CEDE 014586, UNIVERSIDAD DE LOS ANDES-CEDE.
    43. Samuel de Abreu Pessoa & Silvia Matos Pessoa & Rafael Rob, 2005. "Elasticity of Substitution between Capital and Labor and its applications to growth and development," PIER Working Paper Archive 05-012, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    44. Piyusha Mutreja & Michael Sposi & B. Ravikumar, 2018. "Capital Goods Trade, Relative Prices and Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 27, pages 101-122, January.
    45. Oleg Badunenko & Diego Romero‐Ávila, 2013. "Financial Development And The Sources Of Growth And Convergence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(2), pages 629-663, May.
    46. Li Wenli & Pierre -Daniel Sarte, 2004. "Progressive Taxation and Long-Run Growth," American Economic Review, American Economic Association, vol. 94(5), pages 1705-1716, December.
    47. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    48. Lu, Shu-Shiuan, 2013. "The role of capital market efficiency in long-term growth: A quantitative exploration," Journal of Macroeconomics, Elsevier, vol. 36(C), pages 161-174.
    49. Kaoru Hosono & Miho Takizawa, 2012. "Do Financial Frictions Matter as a Source of Misallocation? Evidence from Japan," Discussion papers ron246, Policy Research Institute, Ministry of Finance Japan.
    50. Chen, Yu-Fu & Funke, Michael & Tao, Kunyu, 2015. "Financial market reform – A new driver for China’s economic growth?," BOFIT Discussion Papers 5/2015, Bank of Finland, Institute for Economies in Transition.
    51. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    52. Piyusha Mutreja, 2014. "Equipment And Structures Capital: Accounting For Income Differences," Economic Inquiry, Western Economic Association International, vol. 52(2), pages 713-731, April.
    53. repec:kap:iaecre:v:23:y:2017:i:2:d:10.1007_s11294-017-9632-1 is not listed on IDEAS
    54. Virgiliu Midrigan & Daniel Yi Xu, 2014. "Finance and Misallocation: Evidence from Plant-Level Data," American Economic Review, American Economic Association, vol. 104(2), pages 422-458, February.
    55. Gomme, Paul & Rupert, Peter, 2007. "Theory, measurement and calibration of macroeconomic models," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 460-497, March.
    56. repec:oup:wbecrv:v:30:y:2017:i:supplement_1:p:s57-s66. is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Economic development;

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedrwp:10-05. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Pascasio). General contact details of provider: http://edirc.repec.org/data/frbrius.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.