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Financial institutions and the wealth of nations: tales of development

Tong, Jian and Xu, Cheng-Gang (2004) Financial institutions and the wealth of nations: tales of development. Discussion paper, 484. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Identification Number: 484

Abstract

Interactions between economic development and financial development are studied by looking at the roles of financial institutions in selecting R&D projects (including for both imitation and innovation). Financial development is regarded as the evolution of the financing regimes. The effectiveness of R&D selection mechanisms depends on the institutions and the development stages of an economy. At higher development stages a financing regime with ex post selection capacity is more effective for innovation. However, this regime requires more decentralized decision-making, which in turn depend on contract enforcement. A financing regime with more centralized decision-making is less affected by contract enforcement but has no ex post selection capacity. Depending on the legal institutions, economies in equilibrium chose regimes that lead to different steady-state development levels. The financing regime of an economy also affects development dynamics through a ‘convergence effect’ and a ‘growth inertia effect.’ A backward economy with a financing regime with centralized decision-making may catch up rapidly when the convergence effect and the growth inertia effect are in the same direction. However, this regime leads to large development cycles at later development stages. Empirical implications are discussed.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2004 The Authors
Subjects: H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 30 Jul 2009 16:28
Last Modified: 27 Feb 2014 15:35
URI: http://eprints.lse.ac.uk/id/eprint/24682

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