ABSTRACT
A number of recent studies have used the endogenous growth theory to show the existence of a close association between the level of financial sector development and long-run growth. A positive association between financial development and growth has been well documented since the pioneering statistical work of Goldsmith (1969). In practice, however, governments in developing countries failed to recognise - until at least the end of the 1970s - the need to strengthen the financial system and to set up conditions favourable to financial development. During the 1950s to 1970s, the financial sector was used as an instrument to finance massively interventionist policies based on the development of key industrial sectors which were supposedly 'engines of growth'. These policies mainly took the form of directed credit allocation according to government objectives, and provision of cheap credit (by way of interest rate control and subsidisation) to the alleged key sectors of economic development. Furthermore, repression of the financial system through high reserve requirements and interest-rate controls proved to be an easy source of revenue to governments which lacked efficient instruments of taxation and were running persistent budget deficits.
