Issues and Challenges: An Assessment of the Empirical Evidence

This chapter has conducted an assessment of four interlinked issues in development finance: the nexus between finance and economic growth, misallocation of resources and financial frictions, the role of legal titles, and the role of financial illiteracy in accessing finance. The nexus between financial development and economic growth is quite complex and depends upon the type of finance and the size of the financial sector. Project-based financing appears to be more effective than credit based on tangible collaterals with legal title like mortgages. The literature appears also to indicate a stronger role for stock markets than for banks. The issue of the impact of stock markets will be discussed in another chapter of this book. The chapter has also looked at the issue of the impact of financial frictions upon the misallocation of resources. The literature appears to be unable to provide evidence of a strong effect of the elimination of financial restrictions. The literature, however, has clearly managed to put in the right focus the issue of the size of firms in countries with the largest disparity of total factors productivities (TFPs). Therefore, the issue of the structural small size of firms in developing countries should receive the attention it deserves. The chapter has also examined the literature on the impact of interventions to mitigate financial illiteracy and on the role of legal titles in enhancing access to finance. The literature on financial illiteracy has indicated some consensus that timely and ad hoc interventions can lead to more reliable and effective impacts. However, the literature has also indicated that the mitigation of financial illiteracy might not have the desired impact and, methodologically, that a more rigorous assessment was needed as issues of endogeneity and omitted variables might affect the results of some of the empirical papers. The section on the literature on legal titles concluded that, on their own, legal titles do not appear to lead to more access to finance, in particular if the size of the required loans is small and if there is lack of desirability of the assets pledged as collateral, although they do tend to impact on investment in the property and in human capital, probably as a consequence of the stability brought about by the legal title of ownership.