Financial Development, Growth, and the Distribution of Income

TLDR

Financial intermediation promotes growth by enabling higher returns on capital, and growth facilitates costly financial structures, linking the two in the Goldsmith‑McKinnon‑Shaw view. The study presents a paradigm in which the extent of financial intermediation and the rate of economic growth are endogenously determined. The authors model this relationship by showing that financial intermediation boosts growth through higher capital returns, while growth supplies the resources needed to establish costly financial structures. The model produces a development cycle akin to the Kuznets hypothesis, indicating that as an economy shifts from slow to fast growth, the wealth gap between rich and poor initially widens.

Abstract

A paradigm is presented in which both the extent of financial intermediation and the rate of economic growth are endogenously determined. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures. Thus financial intermediation and economic growth are inextricably linked in accord with the Goldsmith-McKinnon-Shaw view on economic development. The model also generates a development cycle reminiscent of the Kuznet hypothesis. In particular, in the transition from a primitive slow-growing economy to a developed fast-growing one, a nation passes through a stage in which the distribution of wealth across the rich and poor widens.