ABSTRACT
So far we have been examining the scale effects of financial deregulation, namely, the effects on the quantity of investment. However, the literature also emphasizes another channel through which such deregulation may enhance growth. This has to do with the allocative efficiency effect. The idea is that higher interest rates, by inducing the selection of projects with higher rates of return, will raise the average productivity of investment (and hence growth) even if the effect on savings and thus total investment was negligible. While there are those who question the validity of this effect on analytical grounds (see Cho, 1986, 1988; Stiglitz, 1991; references cited therein), nevertheless, this effect continues to be emphasized in the literature (Park, 1993).
