The political economy of finance

This survey reviews the recent literature on the political economy of financial development. Our goal is to highlight the impact of political institutions on financial structure, broadly defined to include not just the size of capital markets and banking systems but also the accessibility of finance, which is to say its distribution across firms and individuals.1 A positive role for financial development in economic growth has been firmly established in recent years. More external funding of private activity precedes economic growth, a result that appears robust to endogeneity (see King and Levine, 1993; Beck, Levine and Loayza 2000). In particular, its effect is not just to accommodate growth but to direct resources. The evidence is that financial development fuels growth in financially dependent and emerging sectors (Rajan and Zingales, 1998; Fisman and Love, 2005) and enhances capital reallocation towards growth sectors (Wurgler, 2000). Yet this evidence does not establish that finance is an independent source of growth. To appreciate the role of finance in growth, we need to understand the ultimate determinants of financial structure