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

Has financial liberalization improved the efficiency with which investment funds are allocated to competing uses? In this paper, we address this question using firm level panel data from twelve developing countries. We develop a summary index of the efficiency of investment allocation that measures whether, and to which extent, investment funds are going to firms with a higher marginal return to capital. We then examine the relationship between this index and various measures of financial liberalization. The results suggest that in the majority of cases financial reform has lead to an increase in the efficiency with which investment funds are allocated.

This study is an attempt to review broadly what the last decade reveals about which policies for crisis prevention or crisis management seem to work and which do not. The empirical investigation tries out a variety of methodological approaches: reasoning from examples of prominent crises of the last eight years, formal probit analysis, a regression tree analysis, conventional regression analysis, and a look at the typical profile of financing during the sudden stop preceding a crisis. The authors seek to draw greater attention to policy decisions that are made during the phase when capital inflows come to a sudden stop. Procrastination---the period of financing a balance of payments deficit rather than adjusting---had serious consequences in some cases. Crises are more frequent and more severe when short-term borrowing and dollar denomination external debt are high, and foreign direct investment (FDI) and reserves are low, in large part because balance sheets are then very sensitive to increases in exchange rates and short-term interest rates. Our point is that these compositional measures are affected by decisions made by policymakers in

The paper develops a model in which both long–run growth rates and credit market development are endogenous. Agents facing idiosyncratic productivity shocks cannot perfectly commit to repay their loans, but the threat of credit market exclusion specifies endogenous debt limits preventing default in equilibrium. A growth push makes credit market participation more valuable and relaxes debt limits, reinforcing thereby the initial growth effect. Moreover, a dynamic complementarity between debt limits gives rise to multiple balanced–growth paths. A high–growth equilibrium with developed credit markets can coexist with one or two low–growth equilibria with underdeveloped credit markets. Low–growth equilibria are more volatile as they are exposed to shocks to the wealth distribution and to sunspot shocks.

This paper-- a product of the Office of the Vice President, Development Economics, and the Poverty and Human Resources Division and Office of the Director, Policy Research Department -- was prepared for the IMF Conference on Income Distribution and Sustainable Growth, June 1-2, 1995. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Patricia Sader, room N8-040, telephone 202-473-3902, fax 202- 522-1153, Internet address mravallionCWworldbank.org. January 1996. (30 pages) Tbe 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 than fully polished. The papers carry the names of the authors and should be used and cited accordingly. The findings, interpretations, 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

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How do borrowers respond to improvements a lender’s ability to punish defaulters? We implemented a randomized field experiment in Malawi examining the impact of fingerprinting of borrowers, which improves the lender’s ability to withhold future loans from individuals who have previously defaulted. Study participants were smallholder farmers applying for agricultural input loans, and were randomly allocated to either: 1) a control group, or 2) a treatment group that was fingerprinted as part of the loan application. Both treatment and control groups were given a presentation on the importance of credit history in ensuring future access to credit. For the subgroup of farmers with the highest ex ante default risk, fingerprinting led to substantially higher repayment rates. By contrast, fingerprinting had no impact on repayment for farmers with low ex ante default risk. Higher repayment for the high-default-risk subgroup is due to reductions in adverse selection (smaller loan sizes) and lower moral hazard (more intensive input application yielding higher farm profits).

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This chapter explores the relationship between poverty and financial markets. The document serves as a guide for operations and policy on the one hand and for research on the other. But the chapter does not distinguish between these two uses. Rather, both are merged into a common goal: policy is based on research and research is geared toward generating policy conclusions. The starting point of each section of this chapter is an explicit structural model. A list of data that would be needed to test the model comes next, followed by an outline of exactly how the data would be used: that is, what procedures or tests would be employed in the analysis. The findings of the empirical work from the analysis are then presented. Then and only then are explicit, detailed recommendations for policy offered. The final section offers a few caveats, notes some weakness, and gives some directions for further efforts along this line. References to the literature are listed by corresponding section at the end of the chapter. The chapter is laid out by topic. The first topic concerns occupation choice and transitions into business. The goal is to use data to identify the real obstacles or barriers to trade. Wealth may appear to facilitate business formation and investment, and so the poor seem to lack opportunities—but that does not explain whether the fundamental problem is commitment and

Studies of early U.S. growth traditionally have emphasized real-sector explanations for an acceleration that by many accounts became detectable between 1815 and 1840. Interestingly, the establishment of the nation's basic financial structure predated by three decades the canals, railroads, and widespread use of water and steam-powered machinery that are thought to have triggered modernization. We argue that this innovative and expanding financial system, by providing debt and equity financing to businesses and governments as new technologies emerged, was central to the nation's early growth and modernization. The analysis includes a set of multivariate time series models that relate measures of banking and equity market activity to measures of investment, imports and business incorporations from 1790 to 1850. The findings offer support for our hypothesis of “financeled” growth in the U.S. case. By implication, the interest today in improving financial systems as a means of fostering sustainable growth is not misplaced.