Financial Intermediation and Growth in Developing Countries

Two main relationships between finance and growth are often emphasized: i) the role that financial markets have in channeling savings towards investment and ii) the informational problems that financial markets are able to solve that would otherwise lead to inefficient outcomes. This paper emphasizes a model where prospective entrepreneurs are evaluated in turn by financial markets on their ability to come up with a successful innovation which determines the level of productivity in the economy. With efficient financial markets loans are made to those who are the most likely to come up with marketable innovations. Because marketable innovations lead to higher growth rates, countries that have more developed financial systems will have higher growth rates. My work differs from previous work in this area in that it differentiates the effects of the domestic financial markets from those of the foreign fmancial markets in allowing for the impact of an increasingly global financial system on an economy