Financial Development and Convergence Clubs∗

This paper studies the economic development process, measured by Gross Domestic Product (GDP), for a large panel of countries. We propose a methodology that identifies groups of countries (convergence clubs) that show similar GDP structures, while allowing for changes in club memberships over time. As a second step we analyze the short-run and long-run effects of finan-cial development (measured by financial intermediary development and stock market development) on the GDP process, and the composition of the conver-gence clubs. We find that the club memberships are quite persistent, but still their compositions change substantially over time. In particular, several EU member countries and East Asian countries are found to belong to a higher GDP club in recent times compared to the beginning of the 1970s. In terms of the effects of financial development indicators on the GDP process, our results partially confirm the theoretical basis for different effects of financial development indicators in the short-run and the long-run. In the long-run, financial development is found to affect the countries ’ GDP level positively. The short-run effects of financial development indicators however are found to be less clear, in the sense that we do not find a negative short-run effect of financial intermediary development on GDP levels, while the short-run effect of stock market development is found to be negative