Let me begin on my thoughts first. I have been reading a bit on what leads to development and growth in a country. It has traditionally been studied by people studying development economics (or dev eco as it is popularly called in campuses). It seeks answer to one question:
- What are the causes of growth? sustainabale growth?
What has been appalling to me most is that most of the works (read academic papers) in this field do not recognise the role of finance in development. The growth literature is quite old but none mention role of finance. Nobel Prize winner Merton Miller remarked "that financial markets contribute to economic growth is a proposition almost too obvious for serious discussion." Alternatively Nobel Laureate Robert Lucas (1988) holds that the role of finance in economic growthhas been "over-stressed" by the growth literature.
How can a country grow without having a good financial system? If it is growing (like China is), then the problems would simply blow up. The objective of the financial system is to allocate finance to the most productive activities in the economy. The better a financial system is at that purpose, the better are the growth prospects in any economy.
It is only recent works by Ross Levine, Raguram Rajan , Luis Zingales, etc. we have some papers, some thoughts on how finance leads to development. Most of the credit however goes to Levine for bringing tons of empirical work on the subject.
There is a lot of work since then and to keep updated of the papers so far, there is an excellent lietrature survey on the above by Levine. Also read the comments by Zingales on the survey. Excellent stuff!!