This paper evaluates (1) whether the exogenous component of financial intermediary development influences economic growth and (2) whether cross-country differences in legal and accounting systems (e.g., creditor rights, contract enforcement, and accounting standards) explain differences in the level of financial development. Using both traditional cross-section, instrumental variable procedures and recent dynamic panel techniques, we find that the exogenous components of financial intermediary development is positively associated with economic growth. Also, the data show that cross-country differences in legal and accounting systems help account for differences in financial development. Together, these findings suggest that legal and accounting reforms that strengthen creditor rights, contract enforcement, and accounting practices can boost financial development and accelerate economic growth.

We document five stylized facts of economic growth. (1) The “residual ” rather than factor accumulation accounts for most of the income and growth differences across nations. (2) Income diverges over the long run. (3) Factor accumulation is persistent while growth is not persistent and the growth path of countries exhibits remarkable variation across countries. (4) Economic activity is highly concentrated, with all factors of production flowing to the richest areas. (5) National policies closely associated with long-run economic growth rates. We argue that these facts do not support models with diminishing returns, constant returns to scale, some fixed factor of production, and that highlight the role of factor accumulation. Empirical work, however, does not yet decisively distinguish among the different theoretical conceptions of “total factor productivity growth.” Economists should devote more effort towards modeling and quantifying total factor productivity.

This paper -- a product of the Finance and Private Sector Development Division, Policy Research Department -- is pa't of a larger effort in the department to understand the links between the financial system and economic growth. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 679-53). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030, telephone 202-473-8526, fax 202-525- 1155, Internet address psintimaboagye@worldbank.org. December 1996. (44 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less tban fully pollsbed. The papers carry the names of the authors and should be cited accordingly. Tbe findings, interpretations, and conclusions expressed m tbis paper are entirely those of tbe author. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent

Recent literature suggests that long-run averages of growth and inflation are only weakly correlated and such correlation is not robust to exclusion of extreme inflation observations; inclusion of time series panel data has improved matters but an aggregate parametric approach remains inconclusive. We propose a nonparametric definition of high inflation crises as periods when inflation is above 40 percent annual. Excluding countries with high inflation crises, we find no evidence of any consistent relationship between growth and inflation at any frequency. However, we find that growth falls sharply during discrete high inflation crises, then recovers surprisingly strongly after inflation falls. The fall in growth during crisis and recovery of growth after crisis tend to average out to close to zero (even slightly above zero), hence the lack of a robust cross-section correlation. Our findings could be consistent either with trend stationarity of output, in which inflation crises are purely cyclical phenomena, or with models in which crises have a favorable long-run purgative effect. Our findings do not support the view that reduction of high inflation carries heavy shor.t-to-medium run output costs.

We show that equity market liberalizations, on average, lead to a one percent increase in annual real economic growth over a five-year period. The effect is robust to alternative definitions of liberalization and does not reflect a business cycle effect. The channel of growth is both increased investment post liberalization which partially reflects a decreased cost of capital and increased factor productivity. The additional investment is largely financed by foreign capital leading to deteriorating trade balances. Some of the liberalization effect can be accounted for by coincidental macroeconomic reforms as well as financial development. However, our analysis shows that even after controlling for a broad range of variables, a statistically significant and economically important role is played by equity market liberalization. We appreciate the helpful comments of Wayne Ferson, Peter Henry, Ross Levine, Graciela Kaminsky,

We are grateful to Yongsung Chang and three referees, particularly the final referee, for useful comments. Saasha Celestial-One provided excellent research assistance. Does Schooling Cause Growth? Barro (1991) and others find that growth and schooling are highly correlated across countries. A model is examined in which the ability to build on the human capital of one's elders plays an important role in linking growth to schooling. The model is calibrated to quantify the strength of the effect of schooling on growth by using evidence from the labor literature on Mincerian (1974) returns to education. The upshot is that the impact of schooling on growth explains less than one third of the empirical cross-country relationship. The model is extended to address the choice of schooling, showing that faster growth can induce more schooling by raising its effective return. Calibrating schooling choices suggests that this reverse channel can potentially explain one half or more of the observed relationship between schooling and

This paper examines the relationship between the legal system and banking development and traces this connection through to long-run rates of per capita GDP growth, capital stock growth, and productivity growth. The data indicate that countries where the legal system (1) emphasizes creditor rights and (2) rigorously enforces contracts have better developed banks than countries where laws do not give a high priority to creditors and where enforcement is lax. Furthermore, the exogenous component of banking development -- the component defined by the legal environment -- is positively and robustly associated with per capita growth, physical capital accumulation, and productivity growth.

Many economists and policy makers believe that education creates positive externalities. Indeed, average schooling in U.S. states is highly correlated with state wage levels, even after controlling for the direct e¤ect of schooling on individual wages. We use variation in child labor laws and compulsory attendance laws over time and across states to investigate whether this relationship is causal. Our results show private returns to education that are around 7 percent, and external returns to education that are in the neighbourhood of 1-2 percent and not signi…cantly di¤erent from zero.

all R&D-performing countries converge to parallel growth paths. All other countries stagnate. Any parameter change that would have raised a country’s growth rate in standard Schumpeterian theory will permanently raise its productivity and per-capita income relative to other countries and raise the world growth rate. Transitional dynamics are analyzed for each country and for the world economy. Steady-state income differences obey the same equation as in neoclassical theory, but since R&D is positively correlated with investment rates, capital accumulation accounts for less than estimated by neoclassical theory. (JEL E10, O40) Cross-country evidence on income differences has been used in recent years to cast doubt

Abstract: This paper examines the connection between the legal environment and financial development, and then traces this link through to long-run economic growth. Countries with legal and regulatory systems that (1) give a high priority to creditors receiving the full present value of their claims on corporations, (2) enforce contracts effectively, and (3) promote comprehensive and accurate financial reporting by corporations have better-developed financial intermediaries. The data also indicate that the exogenous component of financial intermediary development – the component of financial intermediary development defined by the legal and regulatory environment – is positively associated with economic growth.