16. Financial development and economic performance INTRODUCTION I think the question, ‘Why isn’t the whole world rich?’ is the most important question facing economists. (Edward C. Prescott, quoted by Rolnick, 1996) In Parts II–IV, we argued that monetary systems strengthen economic performance by facilitating spot transactions. We now understand that, in addition, ﬁnancial systems facilitate transactions across time. To the extent that such systems economize on transactions costs, they free up resources that the process of trading might have exhausted, and thus ease the ﬂow of resources to higher-valued uses. Rather than beneﬁting a narrow group of ﬁnancial market participants, ﬁnancial development can thus expand economic opportunities more generally. We conclude the present set of chapters with a more careful evaluation of this last implication – that is, ﬁnancial development strongly inﬂuences general economic opportunities. In doing so, we’ll also address this chapter’s opening quotation by arguing that, just as persistent political forces can work against eﬃciency in monetary systems, they can also constrain ﬁnancial systems from realizing their potential. Unless a society’s political organization weakens these inﬂuences, individuals must forgo the expanded opportunities that ﬁnancial development oﬀers. Variation in societies’ success on this political dimension says a lot about why the whole world is not rich. CHANNELS FROM FINANCE TO ECONOMIC PERFORMANCE Several channels exist through which ﬁnancial development can inﬂuence economic performance. Recall from this part’s motivating example that ‘cash-constrained’ ﬁrms must forgo fundamentally proﬁtable projects (see Chapter 13). Economies...
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