Financial Intermediation and Economic Development: A Quantitative Assessment

Abstract

We present a model in which the importance of financial intermediation for economic development can be measured. We generate financial differences by varying the degree to which contracts can be enforced. Economies where enforcement is poor direct less capital to the production sector, and employ less efficient technologies. Calibrated simulations reveal that the resulting effect on output is important. Furthermore, the model correctly predicts that the average scale of production should rise with the quality of enforcement. Finally, we find that the importance of financial development rises with the importance of capital in production.