Financial development and economic growth in developing countries

Abstract

The hypothesis that financial development promotes economic growth in developing countries is largely supported by empirical studies, though contrary evidence also exists. This relationship is re-examined using annual panel data for 44 developing countries for 1974–2001. Three sources-of-growth equations, which are specified from aggregate production functions, are estimated: two are theoretically consistent, while the third uses a common proxy (DEPTH) for financial development. Results show conflicting evidence: the theoretically consistent models show a positive and statistically significant relationship between financial development and economic growth, whereas the proxy version shows the opposite. Measuring financial development appropriately appears critical for policy advice