Empirical Banking: Finance and Growth (Goldsmith & Schumpeter) PDF

Empirical Banking Finance and Growth GOLDSMITH & SCHUMPETER Stefano Caiazza 2024‐2025  Goldsmith (1969) Financial Structure and Development. New Haven, Yale University Press. Goldsmith uses the value of intermed...

Empirical Banking Finance and Growth GOLDSMITH & SCHUMPETER Stefano Caiazza 2024‐2025  Goldsmith (1969) Financial Structure and Development. New Haven, Yale University Press. Goldsmith uses the value of intermediary financial assets divided by GNP to gauge financial development under the assumption that the size of the financial system is positively correlated with the provision and quality of financial services. Using data on 35 countries from 1860 to 1963, Goldsmith finds there are even indications in the few countries for which the data are available that periods of more rapid economic growth have been accompanied, though not without exception, by an above‐average rate of financial development. Weaknesses Controls. It does not systematically control for other factors influencing economic growth (correlation could be explained by country characteristics correlated with both finance and growth). Correlation and not Causality. Such a correlation does not provide any information on the direction of causality between finance and growth. Data. The investigation involves limited observations on only 35 countries (many missing data). Size. The size of financial intermediaries may not accurately measure the functioning of the Financial System. Schumpeter – Economic flow «The circular flow is a stream that is fed from the continually flowing springs of labour power and land and flow in every economic period into the reservoir which we call income, in order to be transformed into satisfaction of wants». The system moves from the static setting to the dynamic one through innovation: it is a change in the existing production system to be introduced by the entrepreneur to make profits and reduce costs. Schumpeter (1912): «The banker, therefore, is not so much primarily a middleman…He authorizes people… [to innovate]». Circular Flow – Macroeconomics (Mankiw) Circular Flow – Macroeconomics (Mankiw)  Schumpeter – Innovation and Credit Any innovation may consist of: (a) The introduction of a new product (b) The introduction of a new method of production (c) The opening up of a new market (d) The conquest of a new source of supply of raw materials or semi‐manufactured goods (e) The carrying out of the new organization of any industry, like the creation of a monopoly The entrepreneur (innovator) is a crucial figure. He is different from a manager and a capitalist. In any economic system, there is a high degree of risk, so the entrepreneur is motivated by: (1) The desire to find a private commercial kingdom (2) The will to conquer and prove his superiority (3) The joy of creating, getting things done or simply exercising one’s energy and ingenuity  Schumpeter – Innovation and Credit Three elements are necessary to the innovator: Technical know‐how Profits Capital Credit and banks play a crucial role in economic development. Credit enables the entrepreneur to buy producer’s goods for conducting new experiments and innovations. The invention in one field of economic activity will induce inventions in the related fields. Thus, credit creation becomes an essential part of the development model.  Schumpeter – Innovation, Credit, and Cycle Entrepreneur demands bank credit to finance innovation Disallineament between the demand for new purchasing power and the new commodities generates inflation. The flow of new supply of goods. Profit for the entrepreneur (primary wave of innovations). Entrepreneur pays back capital and monetary interest to the bank. Rising prices and profits stimulate producers to invest by borrowing from banks. Credit inflation: new entrepreneurs want to enter the market (secondary wave of innovations). Boom. New products reduce the demand for old products, the prices of which decrease. Old entrepreneurs are forced to liquidate their stocks; old firms try to sell goods at a lower price leading to losses. Investments decline, and unemployment rises. Firms try to repay bank debts; the stock of money decreases, and prices fall. Profits decline up to zero. Pessimism. Depression. Without credit, there is no innovation, and development is not possible. Thus, banks are essential and perform a functional role in accumulation and innovation. Cyclical Process of Economic Development  Institutions – Indicators of quality The World Bank – Governance Indicators http://info.worldbank.org/governance/wgi/#home The World Bank ‐ Doing Business http://www.doingbusiness.org/ https://archive.doingbusiness.org/en/doingbusiness https://databank.worldbank.org/source/doing‐business/Type/TABLE/preview/on The Heritage Foundation https://www.heritage.org/index/