The Effect of Financial Development on Convergence: Theory and Evidence

Philippe Aghion, Peter Howitt, David Mayer-Foulkes

NBER Working Paper No. 10358
Issued in March 2004
NBER Program(s):   EFG

We introduce imperfect creditor protection in a multi-country version of Schumpeterian growth theory with technology transfer. The theory predicts that the growth rate of any country with more than some critical level of financial development will converge to the growth rate of the world technology frontier, and that all other countries will have a strictly lower long-run growth rate. The theory also predicts that in a country that converges to the frontier growth rate, financial development has a positive but eventually vanishing effect on steady-state per-capita GDP relative to the frontier. We present cross-country evidence supporting these two implications. In particular, we find a significant and sizeable effect of an interaction term between initial per-capita GDP (relative to the United States) and a financial intermediation measure in an otherwise standard growth regression, implying that the likelihood of converging to the U.S. growth rate increases with financial development. We also find that, as predicted by the theory, the direct effect of financial intermediation in this regression is not significantly different from zero. These findings are robust to alternative conditioning sets, estimation procedures and measures of financial development.

download in pdf format
   (1031 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w10358

Published: Aghion, Philippe, Peter Howitt and David Mayer-Foulkes. "The Effect Of Financial Development On Convergence: Theory And Evidence," Quarterly Journal of Economics, 2005, v120(1,Feb), 173-222. citation courtesy of

Users who downloaded this paper also downloaded* these:
Acemoglu, Aghion, and Zilibotti w9066 Distance to Frontier, Selection, and Economic Growth
Greenwood and Jovanovic w3189 Financial Development, Growth, and the Distribution of Income
Rajan and Zingales w5758 Financial Dependence and Growth
Howitt and Mayer-Foulkes w9104 R&D, Implementation and Stagnation: A Schumpeterian Theory of Convergence Clubs
Levine w10766 Finance and Growth: Theory and Evidence
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us