Financial markets in development, and the development of financial markets

TLDR

It is argued that markets promote growth, and that growth in turn encourages the formation of markets. The study investigates the relationship between markets and development by presenting two endogenous market‑formation models that examine financial markets’ allocation of funds and their role in supporting specialization. The authors develop two endogenous market‑formation models: one analyzes how financial markets allocate funds to the highest‑valued uses, and the other explores how markets support specialization in economic activity. The models show that intermediation arises under weak conditions and that perfect competition has significant consequences for market formation.

Abstract

What is the relationship between markets and development? It is argued that markets promote growth, and that growth in turn encourages the formation of markets. Two models with endogenous market formation are presented to analyze this issue. The first examines the role that financial markets — banks and stock markets — play in allocating funds to the highest valued use in the economic system. It is shown that intermediation will arise under weak conditions. The second focuses on the role that markets play in supporting specialization in economic activity. The consequences of perfect competition in market formation are highlighted.