The Effect of Financial Development on Convergence: Theory and Evidence

Philippe Aghion, Peter Howitt and David Mayer-Foulkes

No 10358, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce imperfect creditor protection in a multi-country version of Schumpeterian growth theory with technology transfer. The theory predicts that the growth rate of any country with more than some critical level of financial development will converge to the growth rate of the world technology frontier, and that all other countries will have a strictly lower long-run growth rate. The theory also predicts that in a country that converges to the frontier growth rate, financial development has a positive but eventually vanishing effect on steady-state per-capita GDP relative to the frontier. We present cross-country evidence supporting these two implications. In particular, we find a significant and sizeable effect of an interaction term between initial per-capita GDP (relative to the United States) and a financial intermediation measure in an otherwise standard growth regression, implying that the likelihood of converging to the U.S. growth rate increases with financial development. We also find that, as predicted by the theory, the direct effect of financial intermediation in this regression is not significantly different from zero. These findings are robust to alternative conditioning sets, estimation procedures and measures of financial development.

JEL-codes: N1 (search for similar items in EconPapers)
Date: 2004-03
New Economics Papers: this item is included in nep-dev, nep-lam and nep-mfd
Note: EFG
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Citations: View citations in EconPapers (40)

Published as Aghion, Philippe, Peter Howitt and David Mayer-Foulkes. "The Effect Of Financial Development On Convergence: Theory And Evidence," Quarterly Journal of Economics, 2005, v120(1,Feb), 173-222.

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Journal Article: The Effect of Financial Development on Convergence: Theory and Evidence (2005)
Working Paper: The Effect of Financial Development on Convergence: Theory and Evidence (2005)
Working Paper: The Effects of Financial Development on Convergence: Theory and Evidence (2004)
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