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Financial structures and economic development

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  • Levine, Ross

Abstract

The author constructs a model that captures the two-way nature of the relationship between financial and economic development - and allows societies at different levels of economic development and with different policies to choose different financial services. In this model, various types of financial contracts and institutions arise in response to the economic environment. Incentives for financial structures to emerge are generated by liquidity and productivity risk, the costs of gathering information and mobilizing resources, and the costs of financial transactions. The emergence and development of financial arrangements in response to the economic environment can alter investment decisions and per capita growth rates - while the level of per capita income helps determine the types of financial services a particular society chooses to develop and use. The author not only reconciles more empirical regularities than past theoretical studies have done, but highlights the role of public policies on financial activities. Policy has important implications for the rate of economic growth, the level of financial development, and the types of institutions providing financial services. The model also predicts that per capita growth rates should be related to the types of financial services provided by the financial sector. Thus, the most common empirical measure of financial development may not appropriately capture fundamental features of financial development.

Suggested Citation

  • Levine, Ross, 1992. "Financial structures and economic development," Policy Research Working Paper Series 849, The World Bank.
    • Handle: RePEc:wbk:wbrwps:849
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    References listed on IDEAS

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