Three essays on financial development and economic growth

by 1969- Kim, Pilhyun

The primary part of my dissertation investigates the potential effects of financial sector development on economic growth. In order to reveal the nature of these effects, I focus on the potential channels of influence from the financial to the real sector. I investigate the link between the financial sector and economic growth focusing on the role of the financial sector in funding innovative activities. To this aim, I construct a model where the economy is driven by innovative activities that require both human capital and external funding. My analysis shows that when certain conditions are satisfied, there exists a unique equilibrium where the growth rate of the economy is jointly determined by the levels of human capital and financial development. An implication of this is that financial liberalization policies that do not adequately address the fundamentals of the economy can cause bank failures and possibly a financial crisis. Furthermore, the model suggests that, depending on the parameter valuesoftheeconomy,theremaybetwoformsofpovertytraps,onewithasmall number of bankers and the other with a large number of bankers. Also, I examine empirically whether financial development has any effect on the rate of technological innovation using patent applications as a proxy for innovative output. For a sample of twenty eight countries from 1970 to 2000, my analysis shows that financial development is indeed significant in raising the growth rate of innovative output. ii In addition, I investigate whether financial development enhances investment efficiency. The efficiency channel hypothesis states that financial development may increase the efficiency of investment by directing the funds to the most productive uses. I examine if there is any evidence of financial development positively affecting the efficiency of aggregate investment using developing countries as a sample. Compared to the volume channel, the efficiency channel has received relatively little attention until recently. I address the issue of the efficiency channel using two alternative measures of aggregate investment efficiency. I find that, for developing countries, financial development significantly and positively affects productivity of investment. iii To my parents and my family iv