Financial Development And Economc Growth

1 Pages 275 Words

Patrick (1966) identified two possible causal relationships between financial development
and economic growth. The first - called ‘demand following’ – views the demand for financial
services as dependent upon the growth of real output and upon the commercialization and
modernization of agriculture and other subsistence sectors. Thus the creation of modern
financial institutions, their financial assets and liabilities and related financial services are a
response to the demand for these services by investors and savers in the real economy
(Patrick, 1966:174). On this view the more rapid the growth of real national income, the
greater will be the demand by enterprises for external funds (the saving of others) and
therefore financial intermediation, since in most situations firms will be less able to finance
expansion from internally generated depreciation allowance and retained profits. For the
same reason, with a given aggregate growth rate, the greater the variance in the growth rates
among different sectors or industries, the greater will be the need for financial intermediation
to transfer saving to fast-growing industries from slow-growing industries and from
individuals. The financial system can thus support and sustain the leading sectors in the
process of growth. In this case an expansion of the financial system is induced as a
consequence of real economic growth.
The second causal relationship between financial development and economic growth is
termed ‘supply leading’ by Patrick (1966). ‘Supply leading’ has two functions: to transfer
resources from the traditional, low-growth sectors to the modern high-growth sectors and to
promote and stimulate an entrepreneurial response in these modern sectors (Patrick,
1966:75). This implies that the creation of financial institutions and their services occurs in
advance of demand for them. Thus the availability of financial services stimulates the
demand ...