Understanding The Background Of Financial Sector And Economic Growth | financial sector and economic growth

There are multiple factors which are considered to be economic growth determinations in the financial sector. One of them is the financial sector's institutional framework. The overall performance of the financial sector and the internal framework of the financial sector are no doubt very important determinants of overall output growth. It is true that an unstable financial sector would have a negative impact on overall economic output. This unstable financial situation will also affect the overall confidence level in the financial sector.

Economic analysts make use of several statistical techniques in order to analyze the financial situation of a country or a state and arrive at a concrete picture of the macroeconomic situation and the inter-relationship among economic variables. Among all these techniques, one of the most popular techniques used is the use of descriptive statistics. A descriptive statistical technique is used to identify and describe the various economic variables which are related to the financial sector and the other macroeconomic variables which are also important determinant for the same.

A descriptive study is very useful in arriving at a general concept of economic growth or condition of a nation. Let us take the example of a particular state or a country. This state or country might be considered to be in a certain condition if it has a low level of debt. However, the correlation between debt and gross domestic product (GDP) is not perfect as both of them are considered to be independent variables. Hence, the state or country may be called poor while the financial sector would be considered to be rich.

A perfect positive relationship between the two variables cannot be claimed at any cost. The imperfect correlation sometimes results into a zero correlation. A perfect example of perfect correlation is the one between the unemployment rate and the gross domestic product (GDP) in the United States. This kind of perfect correlation can only exist between high-income countries and low-income countries with respect to their financial systems.

On the other hand, the perfect opposite relationship between the two variables cannot be assumed. This means that there might be some states or countries which would be considered poor but at the same time an economy or country which would be considered to be extremely wealthy. This happens because of the difference in mentality between the economically backward countries and the highly prosperous developed nations. For instance, suppose a particular state in the United States is considered poor and its per capita income is low, this will also lead to poverty. However, an economically backward country which has a high level of per capita income should also be considered rich.

Another important policy implication of the finance theory is evident from the above example. According to this theory, the low-income countries will become poor if they do not make effective use of public capital, for example in the form of loans from banks and other large institutions. This can result in a negative impact on the overall economic development of the country if the funds are not misused. It also leads to a situation where public goods get unimpeded access by the low-income countries and eventually these would start reducing the level of economic development. Hence, the policy makers should be particularly careful about this aspect.

On another aspect, it is argued that the finance-growth nexus leads to a reduction in the inter-dependence of financial sector development and domestic social development. According to this argument, the finance-sector tends to concentrate on short-term profit maximization and at . . . . . . the same time fail to contribute towards the overall social welfare. On the other hand, there are also other economists who argue that there is no compelling evidence that the financial-sector develops any socially meaningful services. But then, this point of view is largely based upon the lack of empirical research on the matter. There are a few studies that point to the existence of some positive effects of the finance-growth nexus on overall economic welfare; these effects however are of limited magnitude and are too small to be of any significance. The argument on the other hand suggests that the size of the financial sector in a country can affect the extent to which the government can provide public goods.

Lastly, the finance-growth nexus can adversely affect economic growth through the indirect means. One of the ways in which the finance-driven globalization can weaken the role of the state in the economy is through financial sector malpractice. For instance, there have been several instances of financial organizations indulging in insider trading, fraud, corruption, asset stripping and price gouging. Thus, it is pointed out that misuse of the system can lead to a reduction in the welfare state through increase in statelessness and social unrest.

PDF) The Financial Sector and Economic Growth* - financial sector and economic growth
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