Stock Markets, Banks, and Economic Growth

Abstract

Do well-functioning stock markets and banks promote long-run economic growth? This paper shows that stock market liquidity and banking development both positively, predict growth, capital accumulation, and productivity improvements when entered together in regressions, even after controlling for economic and political factors. The results are consistent with the views that financial markets provide important services for growth, and that stock markets provide different services from banks. The paper also finds that stock market size, volatility, and integration with world markets are not robustly linked with growth, and that none of the financial indicators is closely associated with private saving rates. (JEL G00 O16 F36) Considerable debate exists on the relationships between the financial system and economic growth. Historically, economists have focused on banks. Walter Bagehot (1873) and Joseph Schumpeter (1912) emphasize the critical importance of the banking system in economic growth and highlight circumstances when banks can actively spur innovation and future growth by identifying and funding productive investments. In contrast, Robert E. Lucas (1988) states that economists 'badly overstress'