Financial Deepening and Economic Growth in Advanced and Emerging Economies

While over‐financing caused crises and slow growth in advanced economies including G ermany, F rance and the UK after 2008, more prudent financial deepening sustained higher economic growth in C hina and I ndia—two major emerging economies in the world. The actual financial deepening ratios ( AFDR ) observed in the non‐consolidated balance sheet from the OECD exceeded by factors of 3.5, 2.4 and 5.1 the optimal financial deepening ratios ( OFDR ) obtained from the solutions of dynamic general equilibrium ( DGE ) models of those three advanced economies. The corresponding factors were 2.3 and 0.49 for C hina and I ndia respectively. Labor intensive production technology and a low OFDR relative to a high AFDR in C hina allowed it to grow at 10% between 1990 and 2010 period that ended with the global financial crisis. With a reasonable OFDR and low AFDR I ndia also managed to grow at 6.5%. Thus huge gaps between the optimal and actual financial deepening ratios led to massive macroeconomic consequences as observed after the crises in 2008. Smooth, sustainable and efficient economic growth requires adoption of strategies for separating equilibria in line of M iller– S tiglitz– R oth mechanisms avoiding problems of asymmetric information in the process of financial intermediation with as narrower gaps as possible between the AFDR s and OFDR s.