RAVINDER TULSIANI

Summary ofFinance

Introduction2

Is there an important impact of financial development on growth? leading growth-textbooks ignore the financial sector Merton Miller: there is a very obvious contribution

of financial markets to growth Robert Lucas: role of finance has been overstressed

Paper Contents first part provides overview about theoretical and

empirical research regarding above question second part summarizes historical and policy

determinants of financial development

Agenda3

summary of paper contents review of theoretical works review of empirical works

Term „Financial Development“4

focus on five broad functions of the financial system:(1) produce information and allocate capital(2) monitor investments and exert corporate governance(3) facilitate trading, diversification and management of risk(4) mobilize and pool savings(5) ease the exchange of goods and services

„Financial Development“ = lower information, transaction and enforcement costs~ better performance on financial functions

information,transaction,enforcement

coststax,

legal,regulatory

system

financialcontracts,markets,

intermediaries influence onallocation ofresources andthus growth

(1) Producing Information and Allocating Capital

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large information costs in evaluating of firms, management and market conditions before granting a loan Financial Intermediaries bundle efforts and

reduce costs (Boyd and Prescott, 1986) FI produce better information and fund more

promising firms and technologies (Greenwood and Jovanovic, 1990)

FI identify better entrepreneurs and innovators (several papers)

large and liquid stock markets set incentives to research for unique information (several papers)

imperfect capital markets impede efficient investment in human capital (Galor and Zeira, 1993)

(2) Monitoring firms and exerting CG6

Corporate Governance determines the degree to which shareholders can monitor and influence the use of their capital asymmetric information principal agent problems „free rider“ problems among minor shareholders

research on concentrated ownershipresearch on the role of financial intermediaries

economies of scale in monitoring (Bencivenga and Smith, 1993)

better handling of informational asymmetries (Sussman, 1993; Harrison, Sussman, and Zeira, 1999)

monitoring of innovative activities (De La Fuente and Marin, 1996)

(3) Risk amelioration (cross-sectional risk)

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diversification allows risk-averse investors to invest in riskier, higher-return investments (Gurley and Shaw, 1955; Patrick, 1966; Greenwood and Jovanovic, 1990)

diversification can stimulate innovative activity and thus technological change (King and Levine, 1993)

(3) Risk amelioration (liquidity risk)8

liquidity = cost and speed of conversion of financial instruments to purchasing power

some high-return projects require a long-run commitment of capital Hicks (1969), Bencivenga, Smith and Starr (1995)

on Industrial Revolution Levine (1991) on the effects of liquid capital

markets on steady-state growth Bencivenga and Smith (1991) on the role of FI

(4) Pooling of Savings9

Pooling = process of agglomerating capital from many savers for investment works on the emergence and role of institutions:

investment banks (Carosso, 1970) banks (Sirri and Tufano, 1995; Boyd and Smith, 1992;

Lamoreaux, 1995) pooling enables production at efficient scales (Sirri

and Tufano, 1995) works by Bagehot (1873)

(5) Easing trade10

higher specialization allows for technological invention and growth (Smith, 1776) requires more transactions transaction and information costs

emergence of money (Smith, 1776; King and Plosser, 1986; Williamson and Wright, 1994)

Greenwood and Smith (1996) on connections between exchange, specialization, and innovation