Finance and Growth in Developing Countries: Sound Principles and Unreliable Evidence

Valpy FitzGerald (qeh)

QEH Working Papers from Queen Elizabeth House, University of Oxford

Abstract: Financial development and economic growth are clearly related, yet the institutional channels and even the direction of causality remain unresolved theoretical issues. None the less, and despite the persistence of a wide range of organizational forms in advanced economies, strong causality from particular forms of organization of financial institutions towards rapid economic growth has become a central axiom of orthodox development economics, recently strengthened by the empirical findings of 'new institutional' economists. This chapter argues that this canonical literature is deeply flawed both methodologically and empirically. Further, the observed consequences of financial liberalisation for savings and investment on the one hand, and for macroeconomic stability on the other, suggest that an alternative interpretation of the relationship between finance and growth in developing countries is more plausible: leading to quite different policy prescriptions.

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