summary

Joseph Schumpeter argued in 1911 that the services provided by financial intermediaries--mobilizing savings, evaluating projects, managing risk, monitoring managers, and facilitating transactions--stimulate technological innovation and economic development. In this paper, King and Levine present evidence that supports this view through examining the cross-section data of about 80 countries during the period 1960-89. They find that various measures of financial development are strongly associated with both current and future rates of economic growth. Each measure has shortcomings but all gives the same implication: finance matters. They present two main findings, which are robust to many sensitivity tests:(1) The average level of financial development for 1960-89 has a very strong contemporaneous relationship with growth, physical capital accumulation rate and improvements in capital allocation efficiency. (2) Financial development precedes not follows growth. Much work remains to be done, but the empirical results shows Schumpeter might have been right.

To figure out the relationship between finance and economic growth, King and Levine firstly construct four indicators of financial development to measure the services provided by financial intermediaries, which includes the traditional measure of financial depth—the ratio of the size of the formal financial intermediary sector to GDP (LLY); the importance of banks relative to the central bank (BANK); the measure of domestic asset distribution—credit issued to nonfinancial private firms divided by total credit(PRIVATE) and by GDP(PRIVY). At the same time, the four indicators are designed to measure growth and the sources of growth which includes average long-run real per capita G...

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...apita GDP growth over the next 30 years. Overall, the data clearly support the hypothesis that high level of financial sector development predicts subsequent economic growth, and is associated with physical capital formation rate and resource allocation efficiency over the next ten years. Similarly, the basic results are stable and insensitive to various estimation methods.

Based on the empirical results in the paper, the authors conclude that Schumpeter’s view might have been right that financial system can promote economic growth. They also put forward that further research on endogenous technological change like policies that can change the efficiency of financial intermediation will influence the economic growth.

Works Cited

King, R. G., & Levine, R. (1993). Finance and growth: Schumpeter might be right. The quarterly journal of economics, 108(3), 717-737.