chapter  2
31 Pages

Finance and development: A survey of literature

This chapter provides a survey of the theoretical and empirical evidence on the relationship between financial development and economic growth to provide a setting for the ensuing analyses. The chapter is structured as follows:

• Sections 2.2 and 2.3 explain the emergence and functions of financial systems, respectively;

techniques employed are critically appraised and some caveats on the interpretation of the results are highlighted;

• Section 2.7 discusses some key issues which remain unresolved in the literature and require further research;

Financial intermediaries emerge mainly due to information and transaction costs.1 In an economy, some agents may have extra funds while some entrepreneurs may experience shortages of funds to finance investment projects. To raise the necessary funds in the absence of a sound financial system, entrepreneurs have to approach individual agents who have surplus funds to lend. Since the agents have very little knowledge about the investment projects involved, and the entrepreneurs have to find out which agents have surplus funds and how much each is willing to lend, this process turns out to be time consuming and costly.