What is the role of the financial sector in development? Does it really contribute, or does it merely respond to the demands of the real sector? Are markets simply casinos for betting, or do they perform some productive role? Shouldn’t the development community just focus its attention on more important issues, such as health, education, and the real sector?
I hear these questions all the time. It is not surprising because prominent economists also hold conflicting views. Many development economists do not even bother to discuss the role of the financial sector in development. Joan Robinson famously stated “Where enterprise leads, finance follows,” and Robert Lucas has argued that the role of finance in the literature on growth has been “over-stressed.”
But at the other extreme, Joseph Schumpeter observed “The banker…authorizes people in the name of society…to innovate” and Merton Miller stated: “That financial markets contribute to economic growth is a proposition almost too obvious for serious discussion.” This debate is crucial since it affects the decisions of policymakers to prioritize financial sector reforms, and the attention they pay to identifying and adopting appropriate financial sector policies. Where do we come out?