This paper examines whether nancial development facilitates economic growth by scrutinizing one rationale for such a relationship; that nancial development reduces the costs of external nance to rms. Speci cally, we ask whether industrial sectors that are relatively more in need of external nance develop disproportionately faster in countries with more developed nancial markets. We nd this to be true in a large sample of countries over the 1980s. We show this result is unlikely to be driven by omitted variables, outliers, or reverse causality. (JEL O4, F3, G1) A large literature, dating at least as far back as Joseph A. Schumpeter (1911), emphasizes the positive in uence of the development of a country's nancial sector on the level and the rate of growth of its per capita income. The argument essentially is that the services the nancial sector provides { of reallocating capital to the highest value use without substantial risk of loss through moral hazard, adverse selection, or transactions costs { are an essential catalyst of economic growth. Empirical work seems consistent with this argument. For example, on the

This paper -- a product of the Finance and Private Sector Development Division, Policy Research Department -- is pa't of a larger effort in the department to understand the links between the financial system and economic growth. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 679-53). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030, telephone 202-473-8526, fax 202-525- 1155, Internet address psintimaboagye@worldbank.org. December 1996. (44 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less tban fully pollsbed. The papers carry the names of the authors and should be cited accordingly. Tbe findings, interpretations, and conclusions expressed m tbis paper are entirely those of tbe author. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent

For over a century, economists and policy makers have debated the relative merits of bank-based versus market-based financial systems. Recently, however, proponents of the legal-based view of financial development have argued that the century long debate concerning bank-based versus market-based financial systems is analytically vacuous. According to this view, the critical issue is establishing a legal environment in which both banks and markets can operate effectively. This paper represents the first broad, cross-country examination of which view of financial structure and economic growth is most consistent with the data.

Abstract: A growing theoretical literature describes mechanisms whereby even predictable increases in the rate of inflation interfere with the ability of the financial sector to allocate resources effectively. This paper empirically assesses these predictions. The evidence indicates that there is a significant, and economically important, negative relationship between inflation and both banking sector development and equity market activity. Further, the relationship is nonlinear. As inflation rises, the marginal impact of inflation on banking lending activity and stock market development diminishes rapidly. Moreover, we find evidence of thresholds. For economies with inflation rates exceeding 15 percent, there is a discrete drop in financial sector performance. Finally, while the data indicate that more inflation is not matched by greater nominal equity returns in low-inflation countries, nominal stock returns move essentially onefor-one with marginal increases in inflation in high-inflation economies.

Abstract not found

This paper explores the relationship between financial structure – the degree to which a financial system is market- or bank-based – and economic development. Cross-country regressions, industry panel estimations, and firm-level analyses provide remarkably consistent conclusions. Financial structure is not an analytically useful way to distinguish among financial systems. More precisely, countries do not grow faster, financially dependent industries do not expand at higher rates, new firms are not created more easily, firms ’ access to external finance is not easier, and firms do not grow faster in either market- or bank-based financial systems. We find that economies grow faster, industries depending heavily on external finance expand at faster rates, new firms form more easily, firms ’ access to external financing is easier, and firms grow more rapidly in economies with a higher levels of overall financial sector development. Further, we find that countries with legal systems that more effectively protect the rights of outside investors enjoy greater financial development and economic growth. Thus, it is overall financial development and not financial structure per se that is critical for economic progress.

INTERNATIONAL

Fohlin Lack of both theoretical cogency and empirical evidence casts doubt on the Gerschenkronian paradigm of banking and industrial development. Social, political, and regulatory environments may shape nancial systems, and institutions may persist beyond their usefulness. Central features of universal banking arose late in the German industrialization, if at all; those that did may not have stemmed from the banks ' universal structure. In focusing on international di erences among nancial systems, traditional views on the relative bene ts of universal banking may underestimate both the impact of non-institutional factors on development experiences and the similarities in the ultimate e ects of disparate systems. Key words: nancial intermediation, universal banking, relationship bankingFinancial System Structure and Industrialization:

interpretation, and conclusions are the authors ’ own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member countries. Table of Contents I INTRODUCTION........................................................................................... 1

to thank Luciano Greco and Alberto Niccoli for helpful comments, and the Murst Recent empirical studies have shown that the structure of the legal system and the efficiency in law enforcement influence the financial structure of the firm, their ability to gain access to capital markets, and the growth rate of economic systems. This paper uses a simple banking model with ex-ante and ex-post information asymmetries between borrowers and lenders to analyse the effects that the efficiency of the legal system may exert on the credit market. Its main conclusions are: (i) an efficient legal system reduces loan interest rates and, in the majority of the cases, the average amount of defaults on loans; (ii) an improvement in the efficiency of legal institutions improves banks ’ selection procedures only provided the efficiency of the legal system is already high.