Growth and Finance

I review selectively some of the trends in research on the relationships between financial markets and economic growth. Economic theory provides many arguments as to why, given the widespread existence of moral hazard and adverse selection problems in financial transactions, more highly developed financial markets might facilitate faster economic growth. However, it is less clear that summary measures of financial development and structure, widely used in empirical research, are adequate. I review some recent empirical work in this area, and show that apparent effects of financial development on growth may be capturing regional differences, and other factors. There appears to be little empirical support for an effect of financial structure on growth. Much empirical work in this field uses data over short periods of time, of a few decades in length. Looking over longer periods, non‐financial forces of increasing returns in production, increasing returns to agglomeration and falling transport costs appear more important, and the potential role of financial markets rather less. The question of whether finance plays a causal role or merely follows economic development remains an open one.