Financial Development, Growth and Poverty: How Close are the Links?

This paper reviews the evolution of the literature on link between finance and growth. The paper highlights that financial depth is negatively associated with headcount poverty, after taking account of mean income and inequality.

The paper illustrates the pitfalls in equating financial development with financial depth by reference to several specific country experiences:

• China - the provinces with the greatest banking depth have been growing more slowly;
• Russia - deposit growth through the 1980s has left the country with deep banking systems, but rapid inflation following price liberalization made the stock of bank deposits in Russia almost worthless;
• Britain - the credit boom was followed by a crash;
• Korea - the rapid acceleration in monetary depth of the late 1990s coincided with the collapse in growth rates.

Finally the author briefly describes alternative measure of financial development by taking into consideration three infrastructural dimensions:

• Legal Infrastructure: Stronger shareholder rights translate to a greater number of listed firms and with higher stock market capitalization; stronger creditor rights result in a higher level of bank credit and bond finance;
• Regulatory Infrastructure: Empowering market discipline by ensuring information disclosure, and removing discretion results in healthy market growth;
• Ownership Infrastructure (government and foreign): A higher degree of state ownership is associated with lower financial sector development, lower growth and lower productivity. The entry of foreign banks tends to improve the efficiency and stability of the financial system.