University of Chicago
Type of paper: Thesis/Dissertation Chapter
Article review of Finance and Growth; King, R. and Levine, R.
For a long time, there has been a wide ranging debate among economists on the relationship between financial development and economic growth. A large number of them are of the opinion that finance is not a major factor in bringing about economic development. According to the article, these arguments are misplaced because all financial indicators are related in one way or the other to economic development. This is because financial growth or allocation has a direct impact on the distribution of capital throughout the economy. Moreover, the predestined elements of financial growth indicators largely forecast consecutive value of economic growth indicators (Robert & Ross, 1993, p. 729).
Throughout the article, the authors use data that is consistent with their main argument; that financial services inspires economic development by increasing the rate of capital accumulation as well as by advancing the effectiveness with which the economies utilize that capital. However, the authors do not associate any particular policies of financial sectors with long run economic growth. Instead, the article mainly associates the measures of executable government strategies to ensuing economic growth to make policy suggestions.
At the onset, the article begins by examining the current relationship between financial growth, developments and their sources. Additionally, the article also scrutinizes the potency of the empirical link between the main indicators of the level of financial growth in the financial sector and the long-run tangible per capita GDP gains. Keeping all economic and other indicators constant, the authors state that they found a strong and partial connection between the average yearly rate of tangible per capita GDP growth and the average level of growth in the financial sector (Robert & Ross, 1993, p. 721). The article terms this study as a contemporaneous relationship because it looks at average growth rates and levels of financial growth over the same period of time.
In investigating the relationship between financial and economic growth, the authors of the article first look into some of the major financial indicators used today. The first and second financial indicators are mainly used to establish the relative significance of particular financial institutions. These indicators reveal that commercial banks are more likely to offer risk sharing information compared to central banks (Robert & Ross, 1993, p. 718). On the other hand, the third and the fourth financial indicators are mainly used to investigate the overall domestic distribution of assets. Any financial system that channels majority of its credit to state enterprises may not be helping the economy at all compared to one that allocates much of its credit to private enterprises.
To support their arguments, the authors also present the readers with statistical summaries that prove the existence of a relationship between the four financial indicators and the overall economic growth. The article also presents an analysis of some countries that registered faster economic growth and those that registered slow economic growth (Robert & Ross, 1993, p.719). This analysis reveals the existence of a relationship between increased financial depth and the role played by financial institutions including central banks. More importantly, the analysis proves that countries with quicker rates of tangible capital accumulation and allocation appeared to have more developed monetary systems.
On the basis of the theoretical study of endogenous technological transformations, the authors emphasize the idea of creative destruction. Through the application of the above mentioned endogenous technological developments, the authors are able to come up with a more absolute Schumpeterian vision of economic development through integrating major roles for financial intermediaries. For example, the selection and financing of insubstantial and substantial investments that result in innovation. The authors also use widespread regressions to measure the strength of a partial connection between economic growth indicators and the overall financial development.
There are a number of ways through which the relationship between financial development and economic growth can be interpreted. However, the most widely accepted interpretation is that a strong relationship between financial and economic growth is a reflection of a correlation resulting from contemporaneous impacts of several shocks on economic and financial development.
Much of the investigation carried out by the authors is largely meant to establish whether the prearranged element of the financial sector is related to development and its sources. The results of the investigations prove that the predetermined element of financial growth is a good forecaster of economic growth (Robert & Ross, 1993, p. 743). Moreover, the findings of the investigation reveal that financial growth forecasts both the rate of progress and the effectiveness with which economies distribute physical capital and the rate of physical capital accumulation. This is an indication that the relationship between economic development and financial growth is not merely contemporaneous. Instead, it shows that finance plays a key role in bringing about economic growth.
Robert G. K. & Ross L.,(1993). Finance and Growth: Schumpeter Might be Right .The Quarterly Journal of Economics, 108(3) (Aug., 1993), pp. 717-7